Working capital, the cash a business needs to operate from day-to-day, is a term used by lenders to calculate a business’ ability to survive financial challenges. The success or failure of working capital finance lies in working capital management, which determines how the relationship between short-term assets and short-term liabilities fosters benefits for a company.

Understanding the definition of working capital involves a certain amount of knowledge in the finance world, especially when considering working capital factoring and working capital calculation. The formula to calculate working capital is current assets minus current liabilities equals working capital. Take the time to understand working capital key terms:

1. Get a clear understanding of basic working capital calculation terms.

2. Find a predictor of future working capital needs.

3. Delve into more key terms for working capital comprehension

Action Steps
The best contacts and resources to help you get it done

Understand basic working capital calculation terms

The working capital formula is a measure of assets available to overcome financial challenges. The basic formula for working capital is current assets minus current liabilities. Current assets refer to cash or any asset easily turned into cash. Current liabilities include near future expenses or money owed. This formula yields an absolute value for working capital, which does not help predict working capital needed to succeed.

I recommend: Citizens Bank provides a brief explanation with a working capital calculator. For a comprehensive list of balance sheet ratios with analysis, take a look at the University of Wisconsin Center for Cooperatives site.

Use current ratio results as a predictor of future working capital needs

If you are looking for a predictor of ideal working capital needed to succeed, pay attention to the term current ratio. Current ratio calculations show the ability of a business to pay current liabilities with current assets. The formula for this future-predicting ratio is total current assets divided by total current liabilities.

I recommend: First Research provides current ratio information plus other terms used when working with working capital. Accountant Site provides a calculator to help you determine the amount of work capital you need for the following year and working definitions.

Wrap up with a few more working capital terms

Finally, a couple of key terms to wrap up small business working capital basics include inventory turnover ratio and cash flow. Inventory turnover ratio reflects the company's ability to turn inventory into cash assets. Cash flow is as simple as it sounds. It is the movement or flow of money into and out of your business.

I recommend: College-Cram.com provides a description of inventory turnover ratio with a tutorial to work through calculations, and NetMBA.com gives a list of working capital financing ratios explaining inventory turnover ratio too. For an explanation and examples of calculating cash flow ratios, see The Motley Fool.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Know that the premise of the working capital formula rests on the belief that a business will liquidate all assets to pay liabilities and these assets are readily available for liquidation.

Having the cash on hand to operate and be competitive is critical to your success as a small business. So it's critical to anticipate your need for working capital, which is the money used in your business as part of its normal operations. This consists of income minus costs, including inventory, payables and receivables, and insurance.

1. Estimate the amount of working capital you need to have on hand.
2. Consider the cost of labor, supplies, rent, utilities, storage and salaries; and the cost of professional services such as an accountant, lawyer, advertising and PR or marketing firm.
3. Define the stages your business goes through.

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Tap these free online tools to calculate capital needs

Online tools can help save you money because they allow you to do the calculations yourself.

I recommend: Bankrate has small business calculators to determine current ratio, debt to assets ratio, return on assets, gross profit margin and operating profit percentages. Dinkytown has a nifty working capital calculator that can help you define your needs for the next year.

Break your business down into cycles

Determine how many days' worth of products and/or raw materials are inventoried. Also look at how many days are needed for accounts payable to your suppliers and the amount of time it takes to make your product or service sale. You should also determine the time it takes to collect monies owed to you, as well as the time it takes to convert collections into cash.

I recommend: Calculate the cost of your capital with the help of an online tutorial at Expectations Investing.

Estimate costs

Remember to consider any changes that may affect your business, such as the terms and consideration you have with your suppliers and customers, payment terms, overhead and credit terms with your customers. Consider slow periods and adjust your estimates for working capital accordingly.

I recommend: American Express offers 10 tips to small businesses to help them financially manage their business, including an American Express Small Business Credit Card. Chase also offers small businesses an online resource to help them with their business, including small business banking and credit cards.

Find a lender

Loans not only assist with a business startup, they can supply you with working capital when you need to get through slow times or grow your existing small business enterprise.

I recommend: Business Capital offers fixed loans based on your projected annual gross sales with a fixed rate and fixed term. It targets retailers and restaurant owners. Chase targets all business types and AdvanceMe Inc. provides traditional bank loans and alternative funding options such as credit card factoring.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Calculate the cost of capital components.
• •  The cost of debt capital is equal to the interest rate on the business' debt adjusted for tax deductible interest expenses and the cost of equity capital. Calculate the portion of debt and equity to determine the investment investors expect to earn on a minimum return.
• •  Weigh the cost of each kind of capital by the proportion each contributes to the capital structure.

Working capital, often referred to as net working capital or operating capital, measures a company’s ability to operate in a financially efficient and healthy manner. For a small business, working capital is a lifeline for success. Without working capital/available cash, a business is unable to meet financial obligations or capital requirements needed to cover costs of operations, reinvestments and other liabilities.

Making short-term decisions based on cash flow and profitability is the goal of working capital management. These decisions determine a business’ ability to continue operations with sufficient money flow to pay for short-term debt and operational expenses. Being able to maintain this balance of income and debt stabilizes a business and increases their potential for growth. To understand working capital basics, keep the following information in mind:

1. Working capital calculation measures a company’s ability to succeed.

2. Working capital formula helps determine the amount of working capital available.

3. Business working capital provides evidence of the long-term viability of a business.

Action Steps
The best contacts and resources to help you get it done

Clarify the cash fluidity of a business with working capital calculations

Working capital is a measure of a company's ability to handle finances efficiently and provides information on the short-term financial health of a company. It is a concrete method of finding out what cash is available for day-to-day operations, and it gives you an idea of the amount of cash needed to continue day-to-day operations. Therefore, measuring a company's cash assets and liabilities provides a gauge of a company's success rate, and the better you manage your capital, the less money you need to borrow to stay afloat.

I recommend: An article in Investopedia describes the functions of working capital. Expectations Investing provides an online tutorial to figure working capital.

Use working capital to provide vital information for managers

Working capital management involves managing the relationship between working capital and short-term liabilities. You find your working capital by subtracting current liabilities from capital assets. Positive working capital gives you the money to pay off short-term liabilities. Managing working capital appropriately increases a business' opportunity to invest and yield a return for the investors.

I recommend: An explanation of working capital using the working capital formula is available with wiseGEEK. MyInvestment discusses methods of managing working capital.

Incease the possibility of working capital financing

Calculate working capital to explain how your company manages its cash flow. With working capital finance results, the profitability of a company is clear; investors want to see these operational efficiency figures. In addition, banks often require working capital figures from a specified period for a comprehensive picture of a company's long-term performance.

I recommend: Docstoc provides an entire chapter explaining working capital finance. An insider's view of successful management of working capital with tips to improve is available with Bank of America.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Watch business working capital ratios, if there is a decrease, locate the negative cash flow effect and make improvements.