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:
Current Asset | Amount (Rs.) | Current Liability | Amount (Rs.) |
Debtors | Rs. 1.45 lakh | Creditors | Rs. 2.4 lakh |
Unsold inventory | Rs. 30,000 | Outstanding expenses | Rs. 25,000 |
Raw materials | Rs. 10,000 | | |
Obsolete stock | Rs. 4,000 | | |
Cash in hand | Rs. 20,000 | | |
Prepaid expenses | Rs. 1,000 | | |
Total | Rs. 2.10 lakh | Total | Rs. 2.65 lakh |
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 toRs. 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.
FAQs
Your new working capital needs equals the change in Accounts Receivable plus Inventory minus Accounts Payable. For our example, if you project to grow your sales from $500,000 to $700,000, you will need additional working capital of $21,496.
How much working capital does a small business need? ›
While the definition of a good current ratio can vary, generally speaking, between 1.5 and 2.0 is a good ratio to aim for. A current ratio between 1.5 and 2.0 typically shows that you have enough working capital available while using your assets efficiently.
What is the formula for capital requirements? ›
You can calculate the capital requirements by adding founding expenses, investments and start-up costs together. By subtracting your equity capital from the capital requirements, you calculate how much external capital you are going to need.
How to calculate working capital calculator? ›
If you want to use the net working capital formula it is simply the current assets – current liabilities. If you hold assets of 125,000 and liabilities of 100,000, your net working capital is 25,000. The difference between the two is net is a total, but working capital gets reported as a ratio.
How do you estimate working capital in a business plan? ›
Working capital is calculated by subtracting current liabilities from current assets, as listed on the company's balance sheet. Current assets include cash, accounts receivable and inventory. Current liabilities include accounts payable, taxes, wages and interest owed.
How do I calculate working capital requirements? ›
Working capital = current assets – current liabilities. Net working capital = current assets (minus cash) - current liabilities (minus debt). Operating working capital = current assets – non-operating current assets.
What is a reasonable amount of working capital? ›
A good working capital ratio (remember, there is no difference between current ratio and working capital ratio) is considered to be between 1.5 and 2, and suggests a company is on solid ground.
What is the working capital ratio? ›
The working capital ratio is calculated by dividing current assets by current liabilities. This figure is useful in assessing a company's liquidity and operational efficiency. A working capital ratio below one suggests that a company may be unable to pay its short-term debts.
How do you determine capital needed? ›
To determine capital needs for an existing business, calculate the costs of growth and expansion, but don't include items like salaries, utility costs, insurance, and other fixed business expenses. To determine working capital needs, create projections for accounts receivable, inventory and accounts payable.
What is the capital requirement rule? ›
Expressed as ratios, the capital requirements are based on the weighted risk of the banks' different assets. In the U.S., adequately capitalized banks have a tier 1 capital-to-risk-weighted assets ratio of at least 4.5%.
Working Capital = Current Assets – Current Liabilities
It is a measure of a company's short-term liquidity and is important for performing financial analysis, financial modeling, and managing cash flow. Below is an example balance sheet used to calculate working capital.
What is the correct method for calculating working capital? ›
The working capital calculation is:
- Working Capital = Current Assets - Current Liabilities.
- Net working capital = current assets (minus cash) - current liabilities (minus debt)
- Net working capital = accounts receivable + inventory - accounts payable.
Logically, the working capital requirement calculation can be done via the following formula: WCR = Inventory + Accounts Receivable – Accounts Payable.
What is working capital for dummies? ›
What Is Working Capital? Working capital, also known as net working capital (NWC), is the difference between a company's current assets—like cash, accounts receivable/customers' unpaid bills, and inventories of raw materials and finished goods—and its current liabilities, such as accounts payable and debts.
How do you calculate working capital requirement in Excel? ›
Open an Excel sheet on your computer. List all your current liabilities, like accounts payable, in a column, and find their sum. List all your current assets like inventories, accounts receivable, and cash in another column, and find their sum. Subtract your current liabilities from current assets to find your WCR.
What are three examples of working capital? ›
Regular working capital: This is the least amount of capital required to meet current working expenses under normal conditions. Some examples of this capital include salary and wage payments, materials and supplies, and overhead costs.
What is reasonable working capital? ›
Reasonable Working Capital means an amount reasonably determined by Manager at the same time as the monthly financial statements are prepared pursuant to Section 15.02 hereof, but in no event to exceed a sum equal to a ratio of current assets to current liabilities of 2:1 (but excluding from such calculation cash ...
How much capital do I need to start a small business? ›
How much startup funding you need depends on many factors, such as your industry, the products or services or the store location. The cheapest businesses to start may cost as little as $12,000 initially, but other businesses like restaurants can run from $400,000 or more.
What is the minimum capital requirement for small company? ›
The New Definition of Small Company
According to Section 2(85) of the Companies Act 2013, a small company definition meets the following conditions: Condition 1: Paid-up capital of the company should not exceed INR 4 Crores, or such a higher amount specified should not exceed INR 10 Crores.
What is the minimum working capital requirement? ›
Minimum working capital can be defined as the least amount of capital required to keep a business operating without the need to avail a business loan or other funding options to support revenue.
