How much working capital does your business need?
The amount of working capital that you need varies a lot from one business to the next. It depends on the type of business you’re running and the goals that you have for your future growth.
So, if the question is how much capital do you need, there’s really no one-size-fits-all answer. But don’t let that discourage you. We still have a few tips, tricks and downloads up our sleeves to help you understand and manage your working capital.
Working capital is the cash you use daily to make sure your whole operation runs smoothly. In other words, you’re looking at whether or not your current assets are enough to cover current liabilities. It’s also sometimes referred to as operating liquidity, cash flow and current ratio.
You might want to check out this article that goes into the whole concept a little deeper.
Working capital is not just the fuel for your daily operations, it also says a lot about your business.
Positive working capital says things like: “Hey, your business is doing great, you’ve got more than enough cash to meet your short-term obligations. You’ve got great growth potential, keep it up!”
In contrast, negative working capital might say: “It looks like there’s room for improvement here. Let’s start exploring the options available to get a much needed cash flow boost into your business.”
A good starting point is to make sure your available funds are high enough to cover any financial obligations you might have. That ranges from payroll, rented office space, software fees and much more. Of course, this isn’t always possible but it’s the goal you should always be striving for.
Forecasting your working capital, or cash flow, is a useful way of stay on top of your business finances. We’ve put together a cash flow forecast template that you can download here for free. All you need to do is put in the cash you’re expecting to receive, and what you’ll have to spend, to see how your cash flow forecast. You can use it to get a sense of the state of your working capital over a few weeks, months or even a couple of years.
While there may not be a golden rule when it comes to working capital, let’s start with a more general rule of thumb…
If you have a very large business, you might be able to get away with letting your working capital slip into the sub-zeroes. On the other hand, if you have a smaller business – anything from a startup to a medium-sized enterprise – you’ll need to keep your working capital position in the positive.
To take a more calculated approach, you can use the working capital ratio – also sometimes referred to as the current ratio.
The ratio works by dividing your total current assets by your total current liabilities. This measures how fast you can meet all your debt requirements if they all came knocking at your door at once.
In case you’re asking yourself what current assets and liabilities are, we’ve got you covered. Your current assets in this scenario are all the assets in your business that you can turn into cash within a year. And your current liabilities are all the short-term and long-term debt and payables that are due within that same period.
Typically, the higher your working capital ratio is, the better your business is doing. A higher ratio is a great thing. It shows that your business is more flexible and can look into investing in its future. If you’re in a position to think about building your business out then a flex loan up to £100,000 can help light the fire.
If your ratio is lower than 1:1 you might want to look into why this is happening and set your sights on a ratio of 2:1 as first prize for your business. You may also find it useful to read this article about how to improve your working capital position. If your working capital is being impacted by long payment terms from your clients then you could explore invoice finance. It’s a financial tool that lets you access the cash you’re owed in outstanding invoices.
At MarketFinance, we believe that SMEs are building the world. By making finance frictionless, we’re solving the cash flow issues getting in the way of progress. We use smart technology to deliver better access to faster, more affordable finance. Click here for more information about our working capital solutions.
This article was originally published in November 2019 and has been updated in September 2021.