What is business working capital?
Accountants calculate a business’s working capital using this simple formula: current assets – current liabilities = working capital. Current assets are all your business’s cash, inventory and accounts receivable and sales that can quickly be turned into cash. And your current liabilities are everything you must pay out over the next year, like payroll, mortgage payments, short term debt taxes and supplier/vendor invoices. Basically, your working capital is what you have left to work with for the year.
As your plans for growth accelerate, so will your need to grow your working capital, which means increasing what comes in and decreasing what goes out. It all makes sense so far, right?
The question then becomes: How do you calculate just how much working capital you’ll need to grow your business? Sharpen up your pencils and keep reading.
A formula for growth
While calculating your working capital is relatively simple, figuring out how to grow it can require a little work on your part. Many business owners look at historical data to project where they are, where they want to be and what they’ll need to get there.
For instance, let’s say you sell widgets and have $120,000 worth of widgets in your warehouse. Over the next month, you sell $10,000 in widgets and your expenses for the month are $5,000. That means you have $5,000 left for the month. If you multiply this by 12 months, your working capital is $60,000.
This is assuming your assets and liabilities are consistent throughout the year. Many times this isn’t the case because of fluctuating sales, the need to staff up or down, a shortage of parts or products that causes pricing shifts, etc. This is where some forecasting and planning come into play. But for the purpose of this example, let’s say your assets and liabilities stay the same.
Continuing our widget example, if you want to grow your business by 10%, you would need to increase your monthly profits by 10%, or $500. This would make your working capital $66,000 ($5,500/month ✕ 12 months).
How to grow your working capital
If you need access to additional cash to finance inventory and accounts receivable, there are many ways to do that. Depending on your business, goals and timeline, you may want to incorporate one or more of these tips into your plan:
- Increase profit margins – To increase your profit margins, you can increase your revenue by increasing prices selling more units, or reducing costs. If you think your customers may not be able to tolerate a price increase, try negotiating with your vendors to reduce costs or offer volume discounts.
- Improve inventory management – Track and implement more effective inventory management to ensure you have enough supply to meet customer demands — but not so much that you’re tying up extra capital.
- Rework your current debt – Decrease your liabilities by paying off all the high-interest debt you can and consolidating the rest at a lower interest rate.
- Secure working capital financing – If you need access to working capital for payroll, inventory, a supplier payment or any other short-term need, a Chase working capital loan or line of credit may be a solution.
Speak with a business banker to discuss which products can help make your working capital work harder for you so that you can grow your business.