Working Capital Basics

Know the foundational functions of working capital

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.

 

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.
Try: 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.
Try: 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.
Try: 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.

 

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

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