In the realm of business, cash flow serves as the lifeblood, but working capital acts as the health checkup vital to keep your business thriving. Regularly assessing your working capital becomes even more crucial during times of economic uncertainty. This article delves into understanding working capital, its significance, and strategies for maintaining business success.
What is working capital?
Working capital can be defined as the difference between your current assets and current liabilities. It quantifies the surplus (or shortfall) available to sustain your business operations without resorting to selling assets, taking on more debt, or personal contributions. The greater your working capital, the more resilient your business becomes in funding growth and weathering downturns, which in turn leads to long term business success.
Working Capital Formula:
Working Capital = Cash + Debtors + Stock + Work in Progress – Creditors – Taxes Owing
For example, if your business has the following balances:
Taxes Owing: $25,000
Your working capital would amount to $300,000 ($150,000 + $120,000 + $100,000 – $45,000 – $25,000). However, if your business had an overdraft of $150,000 rather than a positive cash balance, your working capital would be zero. This indicates a lack of cash to cover slower debtor payments or increased stock levels, potentially leading to insolvency.
Boosting Your Working Capital: Strategies for Success
Create a Financial Buffer: Ensure you have enough cash to cover at least two months’ worth of sales. Use the average sales value from the last six months as a reference and manage expenses to reach this level.
Debt Management: Explore renegotiating your debt structure. Speak with your bank manager about converting overdrafts into term loans or other options available due to the impact of COVID-19. Collaborate to find the best financial solution for your business.
Negotiate with Suppliers: Engage with your suppliers to improve terms. This may involve discussions about early payment discounts or extended payment periods. Working together can lead to mutually beneficial arrangements.
Tax Planning: Calculate the percentage of sales earmarked for tax payments. Set this money aside in a separate bank account to ensure you can meet tax obligations on time.
Personal Investment: If the above strategies prove insufficient in boosting your working capital, consider investing your own funds into the business to fulfil working capital requirements.
In light of the challenges posed by a post-pandemic economy, performing regular working capital assessments serves as a practical approach to bolster your business’s cash flow. We can assist you in determining your working capital needs and devising strategies to elevate your working capital.
“Embrace change as an opportunity, not a threat. Survival isn’t the endgame; transformative success is.” – Seth Godin
On 22 November from 12-1pm, Sharp Accounting will be running our Cashflow Management Seminar. This will be held at our offices here in Ballarat. Click here to find out more and register at no cost.‘