Working capital is the money small businesses have to cover their day-to-day expenses. It is an important indicator of the financial health of the company. It acts as a cushion and provides opportunities for growth.
Working capital is an important financial metric to understand because it:
Gives you borrowing power: Lenders and other creditors will view it as a measure of the overall health of your business and your business’s ability to take on new debt.
May fluctuate: Even successful businesses struggle to maintain sufficient working capital, especially businesses with seasonal fluctuations and businesses with a high volume of unpaid accounts receivable. Regular analysis of your business’ financial statements, including the balance sheet and income statement, can help you plan to fill potential gaps.
How to calculate working capital
Working capital is the difference between your cash, such as cash or accounts receivable, and money that you owe in the short term, such as payroll, other monthly bills, and debt repayments.
Assets – liabilities = working capital
If you’re short on working capital, getting a small business loan to cover a temporary shortfall is one solution. However, it is not wise to use working capital loans to cover long-term investments, such as real estate.