Whether it's inventory, payroll, or various subscription fees, every business requires cash to run its day-to-day operations. Working capital, or operating capital, is the amount of cash available to a business after deducting all operational expenses.
In effect, the working capital is a measure of the short-term health, liquidity, and operational efficiency of your company. If your current expenses outweigh your current cash, it could indicate financial trouble in the near future. Conversely, having enough working capital to cover your immediate debts can be a sign of a healthy and growing business.
For any small business, working capital is its very lifeline. Working capital for small businesses allows payment for employees' wages, production of goods, leasing of equipment, and more. Without working capital, a small business won't be able to operate its day-to-day business, leading to temporary or perhaps even permanent closure.
Small businesses must always monitor their working capital. One of the ways to do this is through what is known as the Working Capital Ratio. This ratio takes your current assets and divides it by your current liabilities.
A Working Capital Ratio below one means you are not meeting your current debt requirements and will need to figure out how to raise working capital. On the other hand, if your ratio is above one, you have sufficient working capital to cover your present expenses.
Calculating your small business working capital is relatively simple. The formula is as follows:
Working Capital = Current Assets - Current Liabilities
Current Assets is the total of all your short-term assets, including cash in your bank account or money owed to you by customers. Inventory you expect will convert to cash within the next 12 months can also be included in your current assets.
Current Liabilities is the total of all short-term debts, including the money you owe to other creditors and vendors. Your liabilities also include other immediate expenses such as salary, taxes, equipment costs, and building leases.
Ultimately, a positive short term working capital is an indicator of good financial health for a small business.
If your current assets fall short of covering your expenses, figuring out how to get working capital for a small business can be a challenge. Fortunately, businesses can cover the shortfall with a working capital loan.
A small business working capital loan provides funding so businesses can operate and meet payment requirements. You'll see this type of loan packaged as a line of credit, merchant cash advance, or a traditional bank loan. Working capital loan rates vary and will depend on the type of loan you get.
Whether it's due to seasonal slow-downs or an emergency funding requirement, a small business will need to assess how to obtain working capital. Working capital small business loans can help fill the gaps in cash flow and allow companies to continue their daily operations.
The most common circumstances for a working capital loan include:
Qualifying for a working capital loan will vary depending on the type of loan. Traditional loans through banks, for example, will require positive cash flow statements, minimum time in business, and a strong personal credit score.
Small business owners with poor personal credit scores can still qualify for a working capital loan, although the options may be more limiting. In this case, the lender will look primarily at the profitability of your business rather than your credit score.
Lenders will also tend to require businesses to have no bankruptcies or foreclosures, a steady income, and consistent cash flow.
There are many benefits of a working capital loan, including: