Net working capital is the money that bridges the gap between your outgoings and your incomings. It’s the buffer your business needs to stay open while waiting for invoices to be paid or inventory to be sold.
Without sufficient working capital, you won’t be able to stay afloat through the startup phase.
Calculating your business’ working capital gives you a snapshot of the health of your operation. Knowing this figure can help you avoid becoming a statistic by planning for seasonal demands and high growth.
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How to calculate your net working capital
Your net working capital can be calculated with this formula:
Assets - liabilities = working capital
Let’s look at it step by step:
Step 1: Add up your assets
Your business assets are the current tangible and intangible assets you own that can be turned into liquid cash within a 12-month period.
To find the net working capital figure for your business, start by listing all your business assets in a table and adding them up. Common business assets include:
- Cash on hand
- Accounts receivable (money due to come in)
- Marketable securities
Step 2: Tally your liabilities
Next, calculate your liabilities. Your liabilities are the total amount of your company’s obligations and expenses due in the next 12 months. Place all liabilities into the next table and add them up.
Common business liabilities include:
- Monthly operating costs (payroll, rent, taxes, etc)
- Accounts payable (e.g. money owed to suppliers)
- Payments on short-term loans
- Unearned revenue
- Notes payable
- Other short-term debts
Step 3: Subtract your liabilities from assets
When you subtract your liabilities from your assets, you’re left with your net working capital.
For example, Jim's Tyres has $15,000 in current assets and $7,000 in current liabilities. So, Jim's Tyres’ net working capital is $8,000.
Knowing your business capital is the first step in taking control of the health of your business.
If you have a negative working capital over a 12-month period, you’re likely to be in trouble. In that case, your business might benefit from borrowing capital to cover your cash flow.
When to borrow for your business
There are many reasons to seek extra funding for your business. Whether it’s for purchasing new equipment to improve efficiency or covering cash flow in seasonal slow times.
An injection of capital can make the difference between going big or going bust.
According to Digital Finance Analytics’ 2017 SME Survey, 57 percent of Australian businesses are seeking funding specifically for working capital support.
Initially, it can be tricky to figure out how much capital you’ll need and how to get it. Using the formula above will stand you in good stead with smaller lenders who advocate for small business owners.
Most lenders will expect you to submit a business plan in order to consider your loan request. Don’t have one yet? Learn how to write one here.
What’s a working capital ratio?
A working capital ratio is a measure that lenders use to determine the health and liquidity of your business.
To find your working capital ratio, simply divide your current assets by your current liabilities.
Let’s take Jim’s Tyre’s example again and calculate his working capital ratio:
Jim’s assets are $15,000
Jim's liabilities of $7,000
= positive working capital ratio of 2.14
Lenders consider a working ratio between 1.2 and 2.0 as healthy because it shows good liquidity. If the ratio goes too far above 2.0, the lender might consider it a disadvantage. It could mean the business has seen too much growth in a small space of time, which could signal instability.
If your business capital ratio is 1.2 or under, the likelihood of getting a loan for working capital is small, but not impossible.
There are lenders on the market who reduce the threat of closing your doors by offering fast small business loans. But be warned. Sometimes, using these lenders can come with a high-interest repayment rate and hidden fees. Be sure to do your homework before signing on the dotted line.
How to find lenders for a working capital injection
Lenders that are focused on small and medium-sized enterprises (SMEs) are offering loans for qualified businesses for anywhere from $500 to $500,000. They look for businesses that:
- Have an ABN.
- Have been in business for more than six months.
- Make at least $5,000 in monthly sales.
Some offer loan terms of between six and 36 months, and include no upfront or transaction fees nor penalties for early repayments.
To find out which small business lender is right for you, get answers to these questions:
- Are interest rates fixed or variable?
- What are the loan terms?
- Will I be able to repay the loan within the loan term?
- What are the terms and conditions?
- Are there any hidden fees?
- Is there a “honeymoon” period?
Unlike traditional banks, such lenders can give SMEs loan approvals in a shorter time frame. They also offer transparency around processes, terms and conditions and give businesses like yours the chance to thrive.
A healthy business needs healthy working capital
Figuring your business working capital gives you a snapshot into the health of your operation.
Knowing how much working capital you need and where to get it is key to ensuring your doors stay open for years to come.
There are a range of lenders willing to support small business growth projects and loans to help you ramp up for high-traffic periods. Do your homework and choose loans that won’t put extra pressure on your already-stretched finances.
Why not do an audit of your current working capital and see if you need extra support to grow your current operation into the thriving business you really want? You can do this.