Definition of Working Capital

Working capital refers to the short-term financial health of a business to fund its day-to-day operations including recurrent expenses and paying short-term debts. The amount of working capital requires calculating a difference between your current assets and current liabilities. When business owners know their working capital, they also find out and understand their liquidity, which helps in making accurate assumptions and precise decisions regarding the efficiency and financial stability of your business.

The Importance of Working Capital in Business

Higher Return on Capital

If your business operates with lower working capital, it is important to note that you will post a higher return on capital (ROC). As such, shareholders will receive higher profits for their investments. When stockholders and bondholders invests in your business, the ROC helps them to know the extent to which your business turns capital into profits.

Higher Liquidity

Liquidity refers to the extent to which a business can convert its assets into cash without affecting their marked price. Sufficient working capital enables a company to accomplish its short-term obligations. When you have more cash tied in working capital, it means that your business has additional liquidity that discourages external financing. Small businesses can benefit from higher liquidity, which result from improved cash management.

Increased Profitability

The success and profitability of a business depends on the effectiveness of its working capital management (WCM), which involves the management of its current assets and current liabilities. With the fact that short-term liquidity affects WCM, it can also increase your profitability through the proper management of both account payables and receivables.

Increase in the Value of Business

When you have an effective working capital management for your business, you should rest assured that your company will increase in value due to increased cash flow. As the firm heavily invests in short-term resources, its working capital eventually increases because it has to carry out its routine tasks using large cash. Therefore, the value of a business would increase because the cash represents a certain measure of working capital.

Improved Solvency

If a business does not have sufficient working capital to carry out its daily operations, it could lead to financial insolvency, which takes account of bankruptcy, assets liquidation, and endless lawsuits. However, with an effective strategy to manage working capital, you can improve the solvency of your business as a pre-requisite to meet short-term obligations and various operating costs.

Competitive Advantage

Working capital has the potential to help your business gain competitive advantage over rival firms and achieve sustainable growth. If your company has a productive working relationship with other business owners and suppliers, it means debtors are paid on time, which leads to favorable financing agreements including discounts from trade partners.

Constant Production Process

A business that has enough working capital to pay its suppliers promptly would enjoy uninterrupted flow of factors of production. As such, the business will ensure that all customers can purchase and receive their products punctually. In a deeper perspective, firms having an resourceful working capital management can increase the production capacity of certain products when demand increases unexpectedly.

How to Calculate the Amount of Working Capital Required in Your Business

In order to know the amount of working Capital that your business can effectively use to run its operations, ELAOnline provides you with calculator resources to calculate the same. Users can use the working capital calculator to determine the approximate amount of working capital that your business can use to settle its short-term debts.