Depending on how efficient your business is, an increase in income will affect your firm’s working capital. If you’re already leading a lucrative business, then more income should be converted to more working capital. But if the expenses are so high they eat every dollar your business makes, then the increase in income will most likely not improve working capital. To grow the working capital, you firstly need to understand what it is and how it operates.
What Is Working Capital?
In the accounting field, working capital is a standard measure of your firm’s ability to fulfill its short-term duties. It provides the money needed to pay working expenses and fulfill your obligations, such as paying off a short-termed debt or a bank loan. Working capital is “health and fitness” in the financial field. It determinates whether your company can function without depending on external funds. Working capital is calculated by subtracting your company’s current accountabilities from its current funds. Firstly, you will need to know how to calculate working capital.
Current funds or assets are those that will be converted to money within the next year. The main current assets are cash, business receivables, and inventory. Current accountabilities are duties that must be fulfilled by the end of the next year. Main current accountabilities are accrued liabilities, for example, calculated rent expenses that are yet to be paid, or unpaid but earned wages for the workers, debt payments and accounts payable.
The working capital of a firm is positive when the current funds of a company are bigger than current accountabilities, which is good. If it’s the other way around, current accountabilities exceeding current funds, the business has negative working capital, which is very bad.
Find Out In What Way Your Firm’s Working Cycle Affects Working Capital
You can determine your company’s operating cycle by reviewing inventory, accounts payable and accounts receivable. By doing so, you need to find out how long does it take to sell a product from inventory, how many days it takes to pay a seller and how many days on average it takes to collect a claim from a client.
In the best case, the sum of the days a product has spent in inventory plus the days it takes to claim a receivable from a client should be less than the number of days it takes to pay a vendor- this guarantees positive working capital for your business. But, a lot of small business owners need more funds to pay off all the fees and expenses that are due before receivables are collected from clients.
The rate at which your company grows can also affect this equation. Most firms have to invest in fees before receiving money from customers for products. This will most likely increase the needs of working capital beyond the firm’s requires for its current working cycle.
How To Grow Working Capital
If your company lacks the working capital to grow or operate, few ways can help you change that:
- try to reduce total expenses- by doing that, you can help increase your company’s cash flow and profit over time
- move to a long-term accountabilities-shifting your debt to be paid off during longer periods could increase working capital. You can do this by converting your credit cards to longer-term loans.
- put off paying bills- asking sellers for longer terms to pay them can keep more funds in the business. This could also improve the firm’s working cycle which means you’ll need less additional working capital.
- expedite collection of receivables- this brings the funds back into the business sooner and can improve the working cycle.
- have a faster inventory turnover- the more time a product spends in inventory, the more funds are needed to keep it there. Selling out your inventory faster can help your working cycle.
- consult professionals- if nothing else helps, consider contacting experts in this field such as Classic Funding Group.
Find ways to fund additional working capital
If you own a small business that is operating and generating profit, chances are you will need to invest money into your business again. This process is known as “retained earnings”. You should reinvest your profits to pay off your product suppliers, use the profits to increase the receivables, or invest it into your inventory. Essentially, by retaining the profit, you increase the working capital which enables your business to grow.
In case you didn’t retain or earn enough profit to induce the growth, for increased working capital needs you might need to get a loan. But before that, you might want to research types of loans and tips for paying loans back.
As you can see, growing your business can be a complicated job and it needs a lot of work. You need to make additional investments in accounts receivable and inventory for it to expand. But with adequate help from experts in this field, you will grow your working capital in no time.