The Elements of Working Capital
Before we learn how to calculate working capital loans for small businesses, here are a few elements that make up the working capital and impact it.
Any liquid asset that can be converted into cash in 365 days are called current assets. These include:
● Money in the bank account and undeposited cheques received from consumers
● Insurance premiums and other prepaid expenses
● Inventory consisting of finished goods, raw materials, and goods that are still in progress
● Accounts receivable without any consideration of allowances for accounts that are not likely to be paid
● Advance payments on purchases to be made in the future
● The short-term investments that the enterprise wants to sell within a year
● Notes receivable, including the short-term loans to suppliers or customers that will mature within a year
● Receivables like insurance claims, employee cash advance, and income tax refunds
● Money market funds and other marketable securities
All liabilities that are due within one year are your current liabilities and these include:
● Long-term liabilities payable within one year
● Accounts payable
● Taxes payable
● Employee wages
● Interest on loans
● Loan principal that must be paid in a year
● Accrued expenses
● Advance payments for goods and services that are yet to be delivered
Factors that Impact the Working Capital Requirement of your Business
Your working capital financing can be affected by several factors. Here are a few of them that affect the same
Enterprises are usually capable of meeting their short-term obligations with the revenue generated from sales. However, a company with a longer operating cycle would require more working capital to meet the costs incurred during the time.
Type of business:
Some enterprises require a relatively higher amount of working capital to survive in the market. For example, retailers, wholesalers, and manufacturers must maintain a large amount of physical inventory, which necessitates more working capital.
Business goals: A small business looking for a way to expand its operations would require more working capital than an MSME wanting to operate at the same level. Management goals play a major role in determining your enterprise’s working capital requirement.
Steps to Calculate Working Capital
Step 1: Calculate all the current assets (CA)
Step 2: Calculate all the current liabilities (CL)
Step 3: Subtract the CA from CL (CA – CL)
For Example, if you have Rs.50,000 in assets and Rs. 30,000 in liabilities, then your working capital is Rs. 20,000.
Calculating your working capital gives you a clear view of the company’s short term financial health. A positive working capital where the assets are greater than liabilities, means that your company can pay employees, suppliers, debt interests, and other short-term obligations despite a cash crunch, whereas a negative working capital where the liabilities are greater than assets would mean that you need to re-evaluate your financial situation. This is why, you need to assess your working capital financing and learn how to calculate working capital loans for your small businesses