How to calculate the working capital requirements for your business

A business’s working capital indicates the short-term liquidity or ability to meet its short-term expenses and thus signifies its operational efficiency. So, ensure that you make calculating working capital a priority. It will give you an accurate picture of your company’s liquidity standing and highlight any areas that need attention.

The working capital calculation formula

While you can calculate working capital for your business in various ways, most companies prefer to express theirs as net working capital. The net working capital calculation comprises deducting the current liabilities of your business from its existing assets.

Current assets are liquid assets that can be converted into cash within one year. They include debtors or accounts receivable, expenses paid in advance (prepaid expenses), cash in hand, cash at the bank, as well as unsold inventory, work-in-progress goods, and raw materials. On the other hand, current liabilities are the day-to-day debts incurred by a business in its operation. These could be credit purchases made from vendors (accounts payable or creditors), expenses that are yet to be paid for (outstanding expenses), etc.

While making the working capital calculations, the following adjustments need to be made:

• Deduct cash commitments from cash in hand: Buyback of shares, declared dividends, etc.
• Remove non-trade receivables from debtors: Loans to employees.
• Subtract old, wasted, and obsolete stock from the total inventory.

Working capital calculation: An illustration

Let’s assume that your business has the below list of current assets and liabilities:

 
Working capital = Current assets – current liabilities
Working capital = Rs. 2.10 lakh – Rs. 2.65 lakh
So, your company’s working capital is = –Rs. 55,000

Working capital indications

Efficient working capital management will result in current assets exceeding current liabilities. Therefore, your business’s working capital ratio is considered healthy if it is within the range of 1.2 to 2.

• A positive net working capital signifies that your short-term business needs are being met.
• If your net working capital is nil, it means that your company has just enough money to pay for its short-term liabilities.
• A negative net working capital implies that the company requires further debts to meet its current debts.

Monitor your working capital ratio and ensure a low collection period and inventory turnover ratio for efficient working capital management.

Next steps

If your business has a negative net working capital, it could hinder your daily operations and lead to missed business opportunities. In such a case, you should finance the deficit and have a good working capital management policy in place so that your business can operate smoothly without any delays or glitches.

Revise working capital policy

Negative working capital can be managed in various ways. For example, you can cut down on company expenses and ensure that your collection terms are tight and adhered to on the debit side. On the credit front, you could check with your suppliers to extend the payment window.

Fund the deficit with a working capital loan

To give your operating capital an immediate boost, you could consider a working capital loan. A working capital loan from Bajaj Finserv will allow you to quickly bridge any liquidity gaps as it offers funds up to Rs. 80 lakh with approval in just 24 hours.

This means that you can tackle the situation at the earliest, preventing further damage to your enterprise’s operations. Furthermore, you could avail of this loan in a Flexi format so that you can borrow as and when there’s a deficit and prepay when you receive money from debtors. Here, you pay interest only on the sum used and not the whole amount. You also get an option to pay only interest as EMIs, thereby easing a liquidity crunch even further. This unique facility makes these loans best-suited for managing unplanned working capital or cash flow needs.