In a business, there are two financial metrics that owners or businesses keep a close eye on: the working capital levels and the cash flow status. Both financial metrics help businesses to know whether their company will be able to withstand a market downturn or crisis successfully or not.
In this blog, we will understand the working capital meaning, its importance, and its advantages.
Working capital refers to the liquidity level of the business that covers the day-to-day expenses and other short-term expenses. It indicates the short-term financial position or feasibility of the business and how well the company can manage its short-term financial obligations.
The working capital formula is the current assets minus the current liabilities of the business organization.
Working Capital = Current Asset - Current Liabilities
Current assets include raw materials, inventory, cash at hand and bank, account receivable, etc. On the other hand, current liabilities include accounts payable, wages, taxes, short-term debt, interest owed, etc.
A positive working capital indicates the company has enough funds to cover its daily expenses and short-term debt.
Whereas, negative working capital is a situation where current liabilities exceed current assets, meaning, the business is struggling to finance the day-to-day expenses of the business and indicates a financial crisis.
For any business organization, having adequate working capital is very important for business growth. As discussed above, the primary purpose of working capital is to finance daily operations, meet all the short-term debt obligations, and continue to have sufficient working capital using the existing resources.
If a company has sufficient working capital, it can continue to pay its employees, and suppliers, pay taxes, and other expenses, even if there are some cash flow challenges.
It helps to improve the creditworthiness of the business, have better bargaining power with suppliers, and improve profitability. In short, having sufficient working capital ensures value creation and plays a vital role in achieving organizational goals and profitability.
The following are the top 10 advantages of having adequate working capital:
Working capital management is a process of managing a company's current assets and current liabilities in the most effective way to maintain sufficient cash flow and meet all the short-term goals. The goal of effective working capital management is to reduce the operating cycle, free-up cash from the balance sheet, maintain liquidity and reduce dependency on external sources for financing working capital needs.
The efficiency of working capital management can be quantified in three ratios- current ratio, collection ratio, and inventory turnover ratio.
Must Read: Business Finance - Know its Meaning
A business may experience a drop in working capital due to unexpected market conditions or increased expenses in other areas of business. In such a case, the business needs to take steps to improve working capital to ensure stability and remain competitive in the market. The following are the top 5 ways to increase working capital:
If you are choosing to avail of a business loan to meet working capital requirements with Fullerton India, you must check your eligibility for the loan before applying. By using the business loan eligibility calculator, you can check your eligibility for the loan instantly and the amount you can borrow.
You can also use Fullerton India’s business loan EMI calculator to choose the right loan tenure and EMI to increase the chances of loan approval.