How to Calculate Working Capital for A Small Business?

The working capital of any business shows the ability of the business to meet its day-to-day or short-term operating expenses, thereby telling the business owner about its operational efficiency.

Therefore, every business owner must do the working capital calculation on a regular basis to have an exact knowledge of the liquidity of their business and know in advance in case they need to allocate their funds better or take a working capital loan.

How to Calculate Working Capital?

While there are quite a few ways to calculate working capital. The most preferable way used by small businesses is to calculate it as net working capital. Net working capital is calculated by subtracting the current liabilities of a business from its current assets. Before going in further into the working capital formula, let’s have a look at what do current liabilities and currents assets of business consist of:

 Current Liabilities

  1. Outstanding payments that need to be made to suppliers or creditors
  2. Short-term current expenses
  3. Any other short-term outstanding debts that need to be paid off

Current Assets

  1. Current Stock or Inventory
  2. Cash-in-hand with the business
  3. Payments that are to be collected from buyers or debtors
  4. Expenses that have been made in advance

Working Capital Formula

As discussed above, the working capital of a business denotes its liquidity. When a business has more current assets as compared to the value of current liabilities, it is considered to have adequate working capital.

A working capital ratio between 1.2 - 2 is considered to be an ideal working capital ratio. Working capital takes in all the current assets of a business except for cash as it is highly liquid, and changes frequently with receipt or payment of bills. Therefore, it doesn’t provide an ideal measure of the company’s liquidity.

Let’s have a look at an example to see how working capital calculation is done:

The value of total current assets of Amrit’s business are Rs. 36,000. Total current liabilities of his business are valued at Rs. 52,000. So, the working capital for Amrit’s business will be Current Assets - Current Liabilities, i.e.  36,000 - 52,000 = -16,000. Therefore, Amrit’s business has a working capital deficit of Rs. 16,000. Using this information, he can either allocate his funds better, or take a working capital loan.

What Things Does Working Capital Indicate?

When a business owner manages the working capital of their business efficiently, it results in current assets exceeding the amount of current liabilities. The working capital ratio of any business, as we discussed above, is considered to be healthy, if it is in the range of 1.2 - 2.

  1. Positive working capital shows that the short-term expenses of a business are being met easily and the business can focus on growth.
  2. Zero working capital or when current assets = current liabilities, it means the business has just enough funds to meet its current liabilities and can’t focus on growth right away.
  3. Negative working capital means that the business doesn’t have enough money to meet its current liabilities or day-to-day operating expenses and is in need of funds.

Business owners need to regularly monitor their working capital ratio and ensure they have a low inventory turnover ratio and debt collection period for the efficient functioning of their business.

Business owners can also avail collateral-free business loans of up to Rs. 45 lakhs from financial institutions like Bajaj Finserv to meet their operating expenses and focus on the growth and operations of their businesses without having to worry about funds. This NBFC offers business loans with minimal paperwork and quick approval in just 24 hours.

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