Knowing how much working capital your business needs is vitally important for every entrepreneur, but with all the figures and finance jargon that goes into calculating working capital needs, many business owners are left in the dark on this crucial topic. What is working capital why is it important to your business?
Understanding Working Capital
From time to time, your business may experience a short period of low cash flow because you’ve supplied goods to your clients and are waiting for them to pay on your invoices.
Since you’re required to pay for your inventory before you can sell it on to your customers, you may need an extra cash injection to cover the running costs of your business and purchase more inventory while you wait for payments to come through – this cash injection is known as working capital.
Why Working Capital is Necessary
During busy periods where your business receives a large number of orders, you may not have enough capital on hand to purchase the stock you need to fill these orders. A backlog can build up, causing your business to turn away certain clients because there is no capital to purchase inventory.
To prevent this situation, every business should have some type of working capital on hand. Depending on the size of your business and other factors, you have several options when it comes to securing the working capital you need:
Types of Working Capital
- Equity Funds – As a new business owner, you may not have access to financing from a bank. In this case, you may have to inject some of your own cash into the business, which you can recover once your outstanding invoices have been paid.
- Suppliers – If you are on good terms with your suppliers, you may request that they extend their payment terms from 30 days to 60 during busy periods. Many suppliers will co-operate with this request since they will be receiving larger orders from you during peak business periods.
- Financing – As an established business, you can also approach your bank for an overdraft facility or other financing that will allow you some leeway during busy periods while you wait for your accounts receivable to be paid.
Calculating Your Working Capital Needs
Your working capital requirements will change from time to time, depending on how many orders you are processing at a given time – this is why having co-operative suppliers and bank financing is so important to small business owners.
It’s important to keep track of your sales figures and business turnover, and your accountant or financial advisor will be able to help you calculate your exact working capital needs.