Any element that has the capacity to generate and retain financial value is categorized as Working Capital. Therefore, when defining your company’s working capital, take inventory into consideration, since assets and resources have the potential to provide profits through products and services.
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| Understanding Working Capital |
It is also important to consider the funds that the organization has in bank accounts, as well as the funds due to be received, like payments agreed in the long term. All that can be converted into financial figures, like shares, treasury bonds, etc., are all part of the list.
How to calculate the value of Working Capital?
Even though there are specialized companies to calculate Working Capital, it is easy to do this job yourself. The formula is straightforward and does not demand extensive financial expertise:
Net Working Capital (NWC) = Current Assets (CA) – Current Liabilities (CL)
Before proceeding, comprehend the elements of this formula:
What is Net Working Capital?
Net Working Capital is the sum the entrepreneur needs to have at his disposal in order not to incur delays in key payments, including salaries, suppliers and rent. While the "global" Working Capital indicates the company's operationality, the liquid one gives notice of the sum needed in order not to trigger emergency mechanisms.
What then about Current Assets?
It is related to the company's available resources, like cash in hand, due payments, investments, etc. A stronger Working Capital means lower operational risk.
Current Liabilities: Expenses and Obligations
This one is the reverse of the last one: it is short-term financial commitments, like electricity, water, internet, salaries, product values and other monthly expenses. Labor charges and rent are also added.
Financial evaluation:
Once the values have been established, it is important to examine the business's sustainability in the event of adversity. Most use a six-month measuring period, but for an overall view of long-term vision, one year can be the target. The calculation is based on the multiplying factor of monthly expenses and the desired timeframe. This quotient expresses the reserve that will cover unexpected occurrences.
How to build good working capital
Planning is the key to healthy working capital. A common mistake is to pay off all outstanding debts in one month and then spend excessively the next. It is crucial to align yourself with the established financial plan.
Working Capital for new companies:
Financial contribution by partners is one of the solutions for startups. Because the source of this influx of capital is the owners, interest is evaded. The return of these funds must, however, be mutually agreed upon by parties involved.
It is also necessary that the newly formed enterprises possess a fiscal reserve for minimum six months' operation. The caution considers how long it can take to accumulate the brand name and bring consumers in. Contributing too heavily, though, can hurt short-term liquidity among the partners.
And then micro-enterprises?
Three suggestions from experts have been made in order to develop the Working Capital of micro-enterprises:
Factoring: As an option to those who prefer cash in short notice. Then again, come the costs that are involved.
Lines of credit: While convenient, they need to be used with caution because of interest rates.
Online loans: They are fast, but need careful choices and consideration of fees and security.
What about MEI?
Microcredits can be used by individual microentrepreneurs. They are loans up to R$20,000 for investing in the business. It is essential, however, to exercise discernment and management when using these funds.
Did you know about Negative Working Capital?
It is a warning sign, signaling potential imbalances in finances. Yet, it can be a normal stage for growing enterprises.
Revolving and Own Working Capital:
The former pertains to available credits to pay for urgent needs. The latter, on the other hand, is the firm's capacity to pay for its liabilities without borrowing.
Effective Working Capital Management:
To maintain proper management, it is essential to keep an eye on the Working Capital Cycle, which specifies the duration between paying suppliers and receiving payment from customers. Poor management may lead to shortages of cash.
Working Capital is an essential component of a business's financial management, being the capital required to continue daily activities. It includes items that create and maintain value, including inventory, bank resources and sums receivable.
The most fundamental formula to calculate Net Working Capital is to deduct Current Liabilities from Current Assets. While the former includes accessible resources, i.e., pending payments and investments, the latter includes short-term financial liabilities, i.e., expenses and wages. Proper management of this capital is crucial, and it is important to keep track of the duration between payments to suppliers and receipts from customers.
For micro-enterprises and new firms, there are alternative strategies and financial solutions, including partner contributions, factoring, lines of credit and internet loans. MEIs can turn to microcredits provided by institutions.
Lastly, it is important to know about signals like Negative Working Capital, which may indicate financial issues, and the distinction between Revolving and Own Working Capital.