Working Capital Formula

The working capital of a company is calculated by subtracting the total value of its current liabilities from the total value of its current assets. Positive working capital means that the company would be able to pay off its short-term liabilities immediately.

This is the reason why analysts pay special attention to the decline in working capital. In case of a decrease in working capital, they say that the company is overleveraged, is paying bills too quickly, is collecting receivables too slowly, or is struggling to maintain or grow sales. In cases where it increases, they suggest the opposite.

Other ways to analyze the company’s working capital include the receivables ratio, the inventory-turnover ratio, calculating days payable, the quick ratio, and the current ratio.

Smart Working Capital Management

One of the important uses of working capital is its relation to inventory. The longer inventory stays on the shelves of a warehouse, the further the working capital is also stuck.

If businesses are not properly managed, they can consume excessive amounts of money for expansion. This happens when the company uses its cash to pay for all its needs instead of seeking financial help to make these payments. Therefore, the working capital deficit could cause businesses to fail although they may be running at a profit. The smartest companies invest wisely to avoid these situations.

Besides, analysts underscore that the timing and level of a company’s cash flow are crucial for its ability to pay off its liabilities. The working capital, as dictated by the definition, is not as simple if it were to be managed by using its assets to pay off the liabilities. This is not a realistic possibility. There are other requirements outside of this consideration which needs to be prioritized such as operations and payroll obligations.

Overall, working capital is a true indicator of the state of a company’s finances. It has to be managed smartly if the company has to grow in an expected manner.

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A line of credit can be especially helpful when funds are needed urgently, but it is not meant to be utilized for a project or purchase which necessitates drawing on a large amount. Instead, a line of credit is ideally intended as a “safety net” of sorts, which specifically allows quick access to limited funds. When one requires a source of cash flow to keep their doors open, lines of credit can be very beneficial. As the business does not need to reapply each time it withdraws funds unlike when taking out a normal term loan, there is no bother from the average long-drawn application and approval procedure that comes before a traditional loan.

A secured line of credit means exactly what the name suggests – one that gets drawn on your property or asset. In contrast, to avail an unsecured business line of credit, you would not need to put up anything as collateral. For the uninitiated, collateral is “something” that is pledged to guarantee loan repayment; in an event of default, your lender could legally claim the collateral. Most set it up this way to minimize the risk involved in loaning to a business. Clearly, securing a line of credit with, say, a car or house, would put the borrower at some risk, and make the consequences of defaulting more severe and surer for them. This is something which can make the unsecured line of credit option more attractive to the small business owner.

This is not to say one is always better than the other. An unsecured line of credit can also show relative downsides. For one, it generally tends to come with a higher rate of interest and a lower borrowing limit, as well as a shorter repayment timeframe. While for some businesses these things might be acceptable, others would find them to be the opposite.

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