If the working capital formula fills you with dread, read on.
If your working capital formula calculation reveals a business balance sheet with negative working capital – there are things you can do. Prospa is a specialist business lender that supports NZ small businesses with small business loans of up to $500,000 to cover short term financial shortfalls.
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Working capital is a business essential
You need working capital for:
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- Paying staff wages
- Covering invoice gaps
- Purchasing equipment
- Marketing or promotions
- Paying tax bills
- IT upgrades
- Much more
FAQs
Frequently asked questions
Working capital is calculated using the working capital ratio. It is the current assets divided by current liabilities. Calculations greater than 1 reveal positive working capital, less than 1 reveal negative working capital. A higher ratio means more cash flow or working capital.
Working capital is broadly comprised of current assets and current liabilities. Current assets are those which a business can readily convert into cash within the space of a year. Current assets can be broken down into three areas: cash, bank balances and short term financial investments; accounts receivable; and inventory. Current liabilities are general day to day expenses – like accounts payable, rent, utilities, tax bills, short term loan repayments, etc.
Long term fixed assets or investments, such as real estate, collectibles and market securities, should not be included in your working capital formula.
When you use the working capital formula, a ratio of 1.5 or 2 provides a comfortable buffer for a business owner to manage day to day operations. Anything higher than 2 is ok, but a figure like that could indicate the business may benefit from reinvesting some of the working capital back into the business for growth.
Yes, working capital should include cash and any funds in the bank. It should also include any short term liquid assets or investments; accounts receivable; and inventory. Current or short term liabilities are general day to day expenses – like accounts payable, rent, utilities, tax bills, short term loan repayments, or other debt etc.
Long term assets or investments, such as real estate, large amounts of collectibles and market securities, should not be included in a working capital calculation.
Other questions?
