What is working capital and why is it important?

what is the purpose of working capitalThe very lifeblood of any healthy business is represented by its working capital. A lack of operating capital will crush even the most profitable and confident business ventures, that is simply how it is.

Read on for more information on working capital and the high level of importance it has in regard to any company, no matter its size.

Definition of Working Capital

By definition, working capital refers to a business’ current assets minus its current liabilities. With that being said, it is fair to say that working capital basically relates to how much money is available to a company at any given time, after its financial responsibilities have been covered.

An example of this would be, if a company’s balance sheet shows total assets of £200,000 and total current liabilities of £175,000, its working capital would be £25,000. Hopefully that is starting to make some sense to you.

What is working capital ratio? 

Many people use working capital ratio as a synonym for the full amount in £ because calculating it requires you to have a clear understanding of the balance between both current assets and liabilities. So, be aware that this isn’t referring to an actual ratio in this instance.

However, others do use it in the correct sense, which explains the ratio between current assets and liabilities. So, if a company’s liabilities amounted to £10,000 and its assets totalled £30,000, it would be working on a 3:1 ratio. Many people view a ratio that is below 1:1 equals insolvency within a business.

What is the working capital cycle? 

The time taken for net assets and liabilities to be turned into cash is often referred to as the working capital cycle. This metric aids individuals in finding where capital is currently tied up within the running of the company before a return can be made on it.

Thus, businesses would generally want to reduce their working capital cycle as much as possible, in order to improve the efficiency of the organisation. Common methods of achieving this include paying people slower or collecting any receivables quicker.

What is working capital management? 

Working capital management is all about keeping the cash moving in a company; it is a business term that refers to exactly that. In order to sustain a healthy long-term future, all business ventures must balance the recovery of short-term debts with operational expenses that are ongoing.

This never happens by sheer good luck however, but it takes a lot of planning and a highly organised accounting strategy. This method would need to closely analyse the working capital and push the business to maximise it more effectively. If you are running a bigger company, this would require ongoing ratio analysis, management of accounts, and inventory management.

How can I improve my working capital? 

  • Quicker Invoicing Terms
  • Faster collection of invoices
  • Harsher late payment enforcement
  • Credit checks performed on all customers
  • Developed inventory management
  • Effective negotiating with suppliers (better payment terms)
  • Increased levels of financial awareness throughout your business

How can a working capital facility help? 

It is fair to say that when cash flow is halting a business from making progression, short-term financing methods can become lifesaving. You may find success with bank loans or overdraft sources, but those things have become much more difficult to get a hold of in the modern world. Banks now conduct more thorough checks and are far less likely to give funding to anything other than the perfect candidate.

Luckily, invoice factoring or finance, are a great working capital facility for businesses that are up against the wall financially. With this source of funding, a business would sell their invoices to a third party at a slightly discounted rate.

The business receives the cash flow it desperately needs right away and is able to improve its working capital cycle effectively and easily.

As one of the UK’s leading asset-based lending providers, we compare a range of Invoice Factoring, Invoice Discounting and Selective Invoice Finance.

Thousands of businesses across the UK use invoice finance to leverage their unpaid invoices in order to provide an instant cash injection into the business.

Contact us to solve your negative working capital problems today.

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