Working Capital: What It Is and How To Calculate It

What Is Working Capital?

Working capital, also known as operating business capital, is the money a company uses to cover its short-term business needs. This includes daily expenses like utilities, payroll, inventory, rent, and short-term debts.

Business owners need a clear understanding of how much cash flow they have to run operations, meet obligations, and fund business growth.

Components of Working Capital

Working capital measures a company’s liquidity and financial health by representing the difference between current assets and current liabilities.

Current Assets

Any revenue and item your business can convert into cash within a 12-month period is a current asset. This can include:

• Cash
• Short-term investments
• Accounts receivable
• Inventory
• Prepaid expenses (e.g., insurance premiums)

Current Liabilities

Debts and bills your business has to pay within 12 months are current liabilities. These may include:

• Accounts payable
• Payroll/wages
• Short-term debt
• Rent/utilities
• Taxes

A business’s working capital will often depend on the industry. For example, industries like retail receive and process payments much faster, creating enough cash flow at their disposal.

Prequalify for Working Capital

How To Calculate Working Capital

To calculate how much working capital you’ll need, simply subtract your business’s current liabilities from its current assets:

When the difference is positive, a business has positive working capital where enough current assets can cover current liabilities to meet its financial needs. With negative working capital, a business may struggle to fund operations and pay bills. In this case, the business can borrow money through a working capital loan to cover its short-term debts.

Example of Working Capital

If a company’s balance sheet for the end of the year reports $12,000 of current assets and $4,000 of current liabilities, it has $8,000 of working capital.

Working Capital vs. Net Working Capital

While businesses often use “net working capital” (NWC) and “working capital” interchangeably, NWC is the value of assets after considering short-term obligations, like short-term debt and taxes. In this case, knowing the NWC can help businesses determine their liquidity position.

Working Capital Ratio

Another way to measure business liquidity is by finding its working capital ratio (or “current ratio”). To find the working capital ratio, divide the current assets by the current liabilities. A “good” capital ratio varies by industry but ideally falls close to 1.

While a ratio of less than 1 signifies financial struggle, too high a ratio can show that assets aren’t being used efficiently for business growth.

Strategies for Increasing Working Capital

Every company needs a steady income stream to operate and grow, but factors like low sales periods and unexpected debts can obstruct cash flow. Here are ways to boost your working capital and keep business running smoothly.

Refining Inventory Management

Analyzing inventory performance can help determine what’s working and disrupting cash flow. For example, an analysis may reveal slow-moving inventory, which your business can downsize to improve cash conversion.

Improving Accounts Receivable Management

Utilizing automation and AI integration can assist in collecting past-due receivables. These software services reduce manual billing, helping to streamline invoice processing.

Reducing Expenses

Taking account of unnecessary debt helps businesses cut back on spending. For example, you can utilize internal teams instead of expensive external vendors or negotiate lower costs with inventory suppliers.

Borrowing Working Capital

Many small business owners leverage working capital loans from banks and online lenders to increase their working capital.

What Is a Working Capital Loan?

A working capital loan is a short-term financing option businesses use to fund daily operating costs. It offers a flexible option for small businesses that need cash quickly to cover their working capital needs. For example, companies can use a working capital loan to purchase inventory, pay rent, ensure their employees receive their wages on time, and more.

The primary providers of working capital loans are online lenders, as other financial institutions like banks aren’t as inclined to offer them as business financing options. This can be good since banks typically have stricter requirements and longer application processes. Online lenders usually provide quick funding options and have minimal requirements.

Types of Working Capital Loans

Working capital loan options include short-term loans, a business line of credit, and invoice factoring — all of which are secured loans. You can learn more about each type below.

• Short-term business loan: An approved lump sum amount your business agrees to pay back the capital at a predetermined interest rate within a specified term length. Most short-term loans have a repayment term of two years or less, and you pay the same weekly or monthly payment amounts.

• Business line of credit: Works like your personal or business credit card. The lender will grant you access to cash with a set credit limit, and you only need to pay back the amount you use. Similar to a credit card, you only get charged interest for the capital you withdraw.

• Invoice factoring: A kind of financing that enables you to get an advance on outstanding invoices using your accounts receivable as collateral. A factoring company lends a percentage of your invoice upfront and then collects that amount from your customers, along with a factoring fee.

Apply for Working Capital Loan

Advantages of Using Working Capital Loans

A working capital loan doesn’t mean your company is in poor financial health. It could also signify that business is booming, and you need to keep up with demand. Here are some ways business owners use working capital loans:

• Cover emergency business expenses
• Keep business operations flowing smoothly
• Cover cash flow gaps brought on by late payments/unanticipated circumstances
• Get through slow sales months

Is a Working Capital Loan Right for Your Business?

A working capital loan can help businesses get through sales slumps or temporary negative cash flows. If you’re an owner of a seasonal business who could use a lifeline during the offseason, borrowing capital could be the right move for your business. Other businesses that might benefit from utilizing working capital loans include:

• Companies selling made-to-order products that take months to make. They may borrow funds to put orders in without depleting their capital.

• Startups hiring new employees or purchasing equipment. They may also borrow to keep up with demand and help fund immediate needs.

As a business owner, you’ll know what’s best for your business and if working capital financing can help manage cash flow.

Grow Your Business With a Working Capital Loan

To meet your short-term obligations or take advantage of profitable opportunities, you may need to take out loans. Learning about the different loan options can help you decide when you need one.

At Clarify Capital, our dedicated advisors can help you secure financing in as little as 24 hours so that you can focus on running your business. We’ll compare 75-plus lenders to identify the best loan for you.