Full Guide: Everything You Need To Know About Working Capital!
When we talk about sustainability and the growth of a business it is necessary to keep in mind that these two factors depend directly on how the financial health of that company is. If the accounts do not match, if the return is still lower than the investment and if there is not enough working capital to support the venture’s activities, many problems may arise.
According to a study conducted by Sebrae-SP , about 27% of new companies in Brazil close their activities in the first year of operation. This number grows even more and reaches 50% when we talk about deals that close the doors in the first four years of existence.
The same research also reveals that among the main causes of bankruptcy in the country is the lack of planning with regard to working capital . This is because, despite being an essential concept and an important part of the financial management of any business, many business owners consider it as secondary.
Much of an organization’s success is fully tied to good management and positive financial health. So, to help you understand what is working capital , how to calculate, how relevant to your organization’s economic sustainability, and what good results it can bring, we have prepared a complete content.
Continue reading this article and understand everything you need to know about working capital!
What is working capital?
As important as the definition of social capital is the definition of working capital. Therefore, this should be one of the first steps taken by the entrepreneur.
We can understand working capital as all short-term demanded assets in a company. That is, how much the business has to bear the fixed and variable costs and expenses, or the amount that keeps the organization while the money does not return to the cashier. Finances need to be in order and there must be a balance between what goes in (current assets) and what goes (current liabilities).
Thus, working capital is composed of:
- Assets available: money that is already in cash to pay the day to day bills;
- Stocks: amount of resources you need to keep in the company stock;
- Customers to receive: The amount that you need to have to be able to finance the term of payment you give to your client.
We can not therefore confuse working capital with the fixed investment of a business. The latter, in turn, represents the entire structure that has already been acquired for the initial operation of the company, such as real estate, equipment or raw material.
A good example for the use of working capital are the periods of seasonality. It is common that some months are better than others for any company and that sometimes the break-even point is not reached.
It is at this point that well-planned and well-structured working capital makes all the difference. When this happens, it will be responsible for meeting the basic financial demands, such as the payment of employees and consumer accounts.
Within the macro concept of working capital, there are some other specific definitions of the need of each company. Understand what they are:
Net working capital
The net working capital takes into account the ease with which that asset can be reverted in money so that the entrepreneur can account for the financial commitments assumed in the short term by his business.
In this way, it represents the amount of financial resources of the company, except for real estate, since they are not available for day-to-day use.
Negative working capital
Being with negative working capital means that the organization is spending more than it receives and even summing up all the available resources will not be enough to pay all bills.
It is worth noting that if the company is in the beginning or in the expansion phase, it is common that the costs and investments are greater than the return to the cash. This situation should become worrying if it is extended for long periods.
Own working capital
It is the amount the company has to sustain itself and keep running without the need to borrow. Here, all the counts are in equilibrium and the difference between the assets and the current liabilities has a positive balance.
Working capital linked to investments
Working capital can also be used to cover expenses that the company has during the expansion period. For example, if the entrepreneur invests in new technology to increase production, it is necessary to have working capital to finance the largest quantity of raw materials that will be used.
Is there a difference between working capital and cash flow?
The answer is yes! Just as the meaning of working capital can be confused with the fixed investment of a company, some people also mix it with the concept of cash flow . Although complementary, it is important to understand that the two are different things.
While cash flow is characterized by the way money is managed by the organization and by the cash input and output movement, working capital is the value that the firm has to use, ie it is the difference between what went in and what came out.
And between working capital and stock? Is there a relationship?
The answer here is also yes. Nowadays, there is still a large number of companies working with stock of products and, therefore, it should be seen as an integral part of working capital. In addition to representing the money that will come into the box in the future, the stock also generates expenses, such as transportation and maintenance.
How important is working capital to your company?
In addition to ensuring the organization and financial health, thus enabling sustainability, internal development and business expansion , knowing how much your company needs to remain facilitates and helps in administration. Calculating working capital correctly also brings some benefits that allow more assertive and therefore more efficient management. See below what they are:
1 – Assists in risk assessment and management
As we have already said, well-defined and structured working capital is part of the strategy of running a business. It guarantees liquidity to the company and can be converted into cash whenever it is needed. It is at this moment that it also contributes to risk management.
Both in small and medium or large companies, when this analysis is not done correctly can cause many financial, operational and even legal damages. By considering working capital as the main element of cash flow, a risk assessment follows the budget and warns of potential vulnerabilities in the company. In this way, it is possible to anticipate and prevent them.
A good example for this case is the goal setting for default rates. By means of this analysis it is possible to establish the limit point so that the company budget is not impaired and the working capital is not impacted.
2 – Ensures more predictability
Besides losing the credibility of the market, a company that is indebted also has its growth compromised. Therefore, being on the predictability of your finances up-to-date is extremely important to ensuring the organization’s balance.
Since working capital is responsible for paying the short-term accounts, it is possible to plan the future better and avoid short- and medium-term problems and debts that may arise.
3 – Improve financial management and control
Working capital signals how much the organization needs to maintain its own operation. In this evaluation must be understood all stages of the production process, from the raw material to the return of money to the cash.
It is the manager’s role to keep up with deadlines and values in order to anticipate any need for capital. Being aware of this behavior is very important and helps the entrepreneur to understand the business routine, the needs of the business, the verification of the processes, the financial control and the decision making.
4 – It drives the growth of the company
In the business world the opportunities can arise at any moment and you must be attentive and prepared for them. To invest in more modern structures, open new branches, adopt the franchise system or even buy other companies is necessary to have a short term net amount available for such. That’s why, when we talk about expanding a company, having an organized working capital makes all the difference.
What are the risks that poor working capital control can bring to your company?
As we mentioned in the above topics, planning a financial control and knowing the exact amount of working capital are things that bring many benefits to any company.
In addition to identifying the best time to buy, it will be possible to estimate the terms that your business can take and avoid the imbalance between payments and receipts. The short-term accounts are paid, the cash remains positive and there is the possibility of creating wealth in the long term.
When control of working capital is not done correctly, the operational risks to the company increase, jeopardizing the smooth running of internal activities and running the risk of leaving the cash in the red due to the debts that have accumulated.
This inefficient financial management can be considered as one of the main reasons for the breakdown of a company . Unfortunately, if the money is not enough, the company can not resist and can go bankrupt. Therefore, it is indispensable to carry out this control.
How to calculate working capital?
To begin calculating the ideal working capital of your venture you need to identify all the variables that are related to the operation of the business. Some factors that may influence the amount required are:
- The type of business: commercial companies, industries, banks, utilities, among other types of business require different sizes of working capital, since the demands and the cash flow are also different;
- The size of the business unit: working capital calculation depends proportionally on turnover;
- The turnover of stocks: this ratio is also proportional. For example, if a company’s stock is large, but turnover is slow, there is a greater need for working capital;
- The production process: a longer and more complex manufacturing process requires a larger working capital. The type of production is also an influence factor, depending on whether the company operates with machines and automation or with salaried labor;
- Conditions of purchase and sale: if the company uses credit to make their purchases, the working capital may be lower. Now, if sales are also made on credit, working capital must be higher.
Now that you’ve defined and identified the points that help determine the value of your working capital, it’s time to put your hand in the dough and do the math!
First, you need to know what are the current assets (AC), that is, all the resources that, when added together, generate the company’s revenue (cash, inventory, accounts receivable or financial investments). We can consider them as investments, and the larger they are, the longer the average term to return in cash and the more resources will be needed to cover this period.
In addition, you must also plan your company’s fixed cost (expenses such as rent, energy bill, water bills or salaries) and have an estimate of the variable cost of the company (accounts related to the purchase and sale of your products, such as raw material or equipment). To the sum of these two we can give the name of circulating liabilities (PC).
Once you have these two variants determined it is possible to calculate the working capital (CG), which can be represented by the following formula:
CG = AC-PC
Let’s suppose that a company has $ 40,000 to receive from its customers and $ 50,000 of accounts to pay, putting in the equation would look like this:
CG = R $ 40,000 – R $ 50,000
CG = – R $ 10 thousand
This means that the working capital requirement of that business so that it continues to run is R $ 10,000.
The result of this formula can be the key to both success and failure of many ventures. Hence, it is important to calculate working capital correctly and treat it as one of the priorities of your business.
If there is any difficulty in determining such numbers, it is advisable to find a specialist in the area who can guide you.
How to get the working capital for your company?
After figuring out what amount you will consider to establish as business working capital , it is time to find the sources that will help you organize it. If your business is already spinning on its own, and if the account between the lead time of the customers, the size of the inventory, and the vendors’ payment deadline closes positively, you’re doing very well.
Some basic tips are to shorten the time to receive your company, try to negotiate better with your suppliers, optimize inventory and align bonuses with the commercial, sales and control teams so that they worry about securing the best payment times for each one of the areas.
But not all cases are easy this way. It is very common that some start-up companies that need the resource to expand are not able to obtain working capital on their own and therefore need to use expansion strategies or help from third-party sources.
Especially for micro and small business owners, an extra income is critical while costs are still higher than earnings. At such times, joining loans is a recurring practice and when done in an organized and planned manner will bring many benefits and will serve as a kick to leverage business activities.
Understand what are the main modalities that can be used as working capital:
In the vast majority of cases, equipment and materials can be financed by companies. Here there are interest rates previously set and the payment term may be longer. The great difficulty is that there is a demand for real guarantees, such as real estate, own resources and even the object that was financed.
In addition to channeling all expenses in one place, the business credit card also allows for financial planning and control. The payment can be done at once, avoiding possible interest, or in installments.
But beware: if not used properly the credit card can pose a danger and, over time, become a good snow.
The main advantage of overdraft is to be able to be used in an emergency situation, since it is a credit limit available in the checking account in addition to the positive jump that there is. But just like the credit card one needs to use responsibly because the interest rates are too high and can result in a large debt for the company.
Online Unsecured Loans
One of the simplest, quickest and cheapest ways to guarantee your company’s working capital is to opt for unsecured loans online . In addition to having more advantageous rates for the entrepreneur, they are well bureaucratic than the conventional loans. You receive the reply regarding your credit analysis within two days and shortly thereafter the amount is already made available to you.
BizCapital specializes in this type of loan and has as its focus the bureaucratization of this practice to facilitate the life of micro and small entrepreneurs and boost new business.