How to improve working capital
Working capital is an essential part of any business. Your day-to-day operational costs like wages or renting office space rely on a healthy cash balance. On top of that, when businesses look to expand or grow, working capital is vital. Without enough, you simply won’t have access to cash for one-off costs like upgrading equipment.
Any ambitious business owner needs a good grasp of what working capital is and how to manage it. We’ve put together a brief guide to take you through the basics. Read on to find the answers to the following questions:
- What is working capital?
- How much working capital should my business have?
- What can I do to boost my working capital?
- What kind of business finance will improve my working capital?
What is working capital?
Working capital refers to the cash your business has available to cover daily expenses and make investments in its future. Put simply, it’s what’s left over after settling your incomings with your current liabilities (which are any debts you’re paying back, plus operational costs). You might have also heard it referred to as operating liquidity, cash flow or current ratio.
Having strong working capital does more than keep your business running: it also lets you level up. Every business owner wants that little bit extra cash to fund their next stage of growth. So to put money into creating new products or growing your team, you need a strong hold of your working capital. Think of it like the fuel your business runs on.
How much working capital should my business have?
There’s no ‘one size fits all’ approach to deciding how much working capital your business needs to get by. Really it depends on the type of business you run and your goals. Different sectors and business models require different amounts of upfront cash, and will have different debts to settle.
If your business relies on holding a lot of stock, for example, your outgoings will look different to a software company. What you should focus on is how many financial commitments you have and how regular they are. This involves some planning and forecasting on your side. When you’re clear on exactly how much your daily, monthly and yearly expenses are, you can start looking at how to increase your available cash. In other words, boost your working capital.
To give yourself the most honest picture of your cash flow, you’ll want to work out your working capital ratio. This might sound a little complicated but it’s very straightforward. It’s calculated by dividing the total current assets of your business by the total current liabilities. To break that down, your assets are anything your business owns that you can turn into cash within a year. And in layman’s terms, liabilities are simply any debt (short or long-term) your business has, plus any bills and other expenses you need to pay during the same period.
The higher the ratio, the better state your working capital is in. If the ratio you come out with is lower than 1:1 then your working capital will be negative. In this case, you’ll want to look at what action you can take to bring it into a positive ratio. While some big businesses can get away with a negative working capital ratio, start-ups and small or medium-sized businesses need to try and keep it positive.
What can I do to boost my working capital?
Let’s take another look at what goes into calculating your working capital ratio. On one side, you have your business assets, and on the other, all your payables. So, to boost the ratio, you’ll want to either reduce the money going out or increase the assets and cash in the business.
Here are a few things you can do to manage your outgoings:
- Streamline your inventory – review the volume of raw materials or finished goods you have. Is there a way to lower the amount you purchase?
- Change suppliers – can you get a better deal working with a different supplier? Shop around to see what the best offer is. You could also use your research to negotiate your existing rates and payment terms to agree a discount.
- Work on better terms with your debtors – try to get your customers to agree shorter payment terms with you so you get the cash you’re owed faster. This could be an incentive plan so they are motivated to pay their invoices on time.
- Manage your own payments – don’t let bills add up. Pay your own invoices on time so your cash flow planning is more reliable.
- Expand your revenue streams – could you introduce add ons or other options to your customers to increase the cash coming in?
In short, the faster you get paid compared with when you need to make your own payments, the healthier your working capital will be.
What kind of business finance will improve my working capital?
If you feel you’re already running a tight ship, or are looking for a more generous cash flow boost, it’s time to think about business finance. You might be hesitant to take on debt but, having the right funding will allow you to make those improvements and strategic decisions that drive your business forward.
As with everything, it’s about balance. What works for one company won’t be right for another. And with so many options available, it can be a little overwhelming to know what’s right for you.
Here are the most common kinds of financial support you could explore:
Bank overdraft – much like a personal bank account, a business overdraft allows you to access more cash than you have available. It’s worth noting that there are still interest payments involved and there’s a limit to the amount you can access.
Business loan – this is probably what your brain jumps to when you think of business finance. It’s a great (and fast) solution to fund new projects or improvements that require a lot of cash up front. The Recovery Loan Scheme currently offers viable businesses up to £10 million of government-backed funds, to speed up their post-pandemic recovery. You can find out more about our involvement in the scheme here. At MarketFinance, we’ve given tradition a twist by offering flex loans between £5,000 and £100,000. Similar to a credit card or overdraft,you can access your whole flex loan at once, or withdraw smaller amounts whenever you want to. We like to think of it as working capital on demand. Learn more about how it works and apply here.
Invoice finance – these facilities give you an advance against your outstanding invoices. You get a percentage of the cash you’re owed upfront, and pay a fee to the provider. At MarketFinance we offer two invoice finance solutions that allow you pick and choose which invoice to fund on a pay-as-you-go or subscription basis. If you think these would be a good fit for your business then head to our website to learn more and apply.
Boosting your working capital is easier than you think
There are a lot of options out there for businesses of all sizes. Getting a hold on your incomings and outgoings is the first step to improving the cash available to you. And understanding where your funds are going is key. Once you’ve streamlined your balance sheet you should find your cash flow easier to manage.
The finance options available cover a vast range of funding needs. So if in doubt, chat to a provider or a broker. If you’re interested in exploring the options available to you but aren’t sure where to start then try our eligibility checker. It’s free, no-commitment and will give you tailored advice for your business in just a couple of clicks.