How Much Working Capital Does Your Small Business Need to Survive?
Every business, no matter the size, needs to have working capital on hand or at least easily accessible. You’ll need to use it for inventory purchases, salaries, emergencies and everything in between. As it’s such an integral component of any business, it’s important to understand it and how it applies to yours.
What does working capital really mean?
By definition, “working capital is the difference between a company’s current assets, like cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and current liabilities, like accounts payable.”
Calculating the amount of working capital you have on hand is fairly easy - use this formula:
Working Capital = Current Assets - Current Liabilities
In less technical terms, it’s the money you have sitting in the bank while you wait to get paid by your customers.
When should I consider a working capital loan?
There are several instances a boost in working capital might be necessary to help your business grow. These two situations are the ones we hear about most:
You’re short covering operational costs
When you can’t cover costs with your on-hand working capital, a small business loan can get you through the rough patch. If you’re planning on sourcing this financing from a bank, you’ll need to prepare in advance as turnaround times can be lengthy. If you choose to go with an alternative lender, such as Evolocity, you can get the funds you need significantly faster, often in a matter of days.
You expect to turn the loan into profits
If taking on debt now can help your business generate more than enough business to cover the cost of capital, taking the loan makes a lot of sense. For example, your busiest time of year is coming up but you don’t have enough working capital to stock-up on enough inventory to make the most of it. With a small business loan, you’ll be able to purchase what you need and turn it directly into profit.
What is the best way to manage my working capital?
Now that you know what your working capital situation is, you can focus on managing it more effectively. Here are our 3 tips for doing so:
Avoid clearing your bills all at the same time, stagger your payments
Many large reoccurring businesses expenses like rent and utilities tend to have the same pay cycle. This means that one day a month your cash flow could be taking a major hit. You want to avoid having to dig your business out of a hole so planning your billing cycle strategically is the key. While all your bills may be due within the same monthly period, the “pay by dates” can differ and you can use this insight to your advantage.
Plan your rainy-day fund and secure financing before you need it
It’s a good practice to anticipate your businesses financing needs before they arise to prevent some unforeseen expense from putting a major dent in your cash flow. If an unaffordable expense comes rolling around unexpectedly, securing financing to act as an emergency fund will give your business something to fall back on.
Know your highs & lows inside out and plan accordingly
Without proper planning beforehand, it can become difficult to cover operating costs in slower seasons. Understanding the seasonality of your business can help you plan for these situations. The seasonal peaks may not be too drastic for your business, but they’re present nonetheless. It’s crucial you understand your particular business cycles so you can plan staffing and expenditures accordingly.
Being in complete control of your cash flow isn’t possible; there’s no magic crystal ball to foretell your future sales, as nice as that would be. Your primary goal should be to understand what works best for your business so that you can manage the unpredictable ups and downs in the most effective way possible.
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