Things You Must Know About Working Capital - Loan Trivia

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Wednesday, 6 March 2019

Things You Must Know About Working Capital

Working capital is basically the sum needed for funding a business’ day-to-day operations. It is needed for paying short-term debts, as well as covering other expenses needed for operations.

How to Calculate Working Capital?

The calculation is easy, as you can do it by subtracting the current liabilities from your current assets. The current liabilities are your short-term accounts or debts that need to be settled within a year or so. It includes overdrafts, accounts payable, sales tax, wages and payroll expenses.

The current assets are the business assets that you can convert into cash within a year. It comprises inventory, cash receivable and short-term investments. The current assets must be more than liabilities for positive working capital.

When a Firm Needs Working Capital?

Working capital is crucial whether you are a start-up, growing or an established firm. You need it for your day-to-day expenses like operations costs, payrolls and to pay to the creditors.

You need it, even more, when the firm is trying to make a big step for business growth. For instance, when a business is planning to start a large project, a large working capital is needed for the ongoing period. If a business doesn’t have large working capital, they may apply for a working capital loan to fulfil their financial requirements.

Working Capital Cycle

The working capital cycle is the time taken by inventory to turn current assets and liabilities into cash.

Calculation:

Working Capital Cycle = Inventory turnover in days + debtor turnover in days – creditors turnover

How to shorten the working capital cycle?

Following are some effective ways to shorten the working capital cycle:

Reduce the credit period given to customers and also reduce the average collection period.

Focus on different ways to streamline the manufacturing process and increase sales. It will reduce the time taken for inventory to convert it into sales. Early clearance of stock also improves better working capital cycle.

For reducing the working capital cycle, increase the credit period from your suppliers of goods and raw materials needed for production.
Read Also: EVERYTHING YOU NEED TO KNOW ABOUT THE LIFE CYCLE OF WORKING CAPITAL

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