If you own a company, and expect to be able to financially meet the daily obligations of running it, then maintaining the available cash that enables you to do so – known as your working capital – is essential to not just achieving success, but keeping your doors open for business on a day-to-day basis.
Working capital covers the expenses that any business owner will run into on any given day, ranging from meeting payroll obligations for your employees, purchasing inventory, paying rent or electric bills, and any other re-occurring financial demand of basic operations. It's important, however, to build working capital that not only is capable of meeting your regular monetary commitments, but also is sufficient to allow you the ability to continue to grow your business and avoid stagnation.
A surplus of working capital is vitally important for any company interested in sustaining regular growth by a number of means, including procuring additional inventory and staff in the effort of increasing sales and attracting new customersBut to understand what working capital really is, you need to take into consideration all aspects of a business’ worth; the current assets of a business – for instance, when you take away any current financial liabilities – known as “net working capital.” When you’re taking into consideration the current assets of any given company when attempting to establish its net working capital, you’re looking at any short-term assets that can be quickly converted into cash, such as via the liquidation of inventory or money owed to a company by its debtors (its receiveables). Current financial liabilities, on the other hand, consist of any debt that is due within the span of one year, such as money owed by a company to its creditors (its payables).
To know how much working capital a given company needs in order to sustain its operations and remain in the black, an owner needs to have a thorough understanding of how his business functions and flows in a financial sense. How fast are sales of inventory or services turned into actual cash assets? And how fast does cash, in turn, go towards any debts the company may have? This accounts for a cycle in your working capital known as “turnover rates” when it comes to any regular, re-occurring debt owed or received. Turnover rate allows you to calculate (to an approximate degree) your needs in terms of working capital, allowing you to work out the amount of inventory you currently possess in stock, the amount of time it takes customers to remit payment to you, and the deadline before debt you own is due to vendors or creditors. Once this has all been worked out, you will finally have a true grasp on what exactly your working capital is.
So, how does a company go about acquiring working capital after all of that? Well, the main way is to establish business practices and an in-demand product or service that ensures a regular and steady flow of income; this will ensure that your profits exceed your expenses, paving the way to ample working capital. But, short of that, there is what’s known as a "business line of credit". Sometimes, through no fault of a company owner, profits can temporarily ebb and flow via a number of factors, be they due to the economy, seasonal needs, or anything else. To help a company get over that hump while they edge their way back to a profitable state, they can work out an arrangement with a bank or other lending institution on a loan; however, unlike a traditional loan where the money is given to the borrower in full up-front, a business line of credit establishes a maximum amount of money upon which a company can draw upon and repay at will in order to meet the daily financial obligations of doing regular business.
An advantage of a business line of credit is that there are no large fees or heavy interest rates that one would normally associate with a corporate credit card; instead, companies work out fixed payments with a lender that are calculated by an adjustable market-based interest rate, and the amount of the loan can often be paid off in full at any time without any early payment penalties. The company only borrows however much they need from the pre-determined amount, and thus only has to reimburse the lender for however much they have taken.As you can see, working capital – regardless of how it’s acquired, be it through effective business practices, the occasional use of a businesses line of credit, or a combination of the two – is the driving force behind any successful company.
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