Working capital is basically the financial resources that a company needs to continue functioning and performing its activities.

It’s responsible for keeping your company in business at various times, mainly when sales or service revenues are delayed and your company needs cash to cover its basic expenses.

In this article you’ll find out about the importance of working capital to a company as well as how to calculate it through a very simple, didactic explanation. Take a look!

The importance of working capital to a company

You already understand that working capital is the amount of financial resources that a company needs to keep a business running. This definition is already enough for you to understand its importance to your company.

It’s important when company management wants to make an investment that will generate returns in the future, because this money will cover the company’s costs until the moment this invested money begins to return to the firm in the form of revenues.

Working capital is also very important in terms of sales and services when payments for these operations will only be received at a later date.

Another important use for working capital is related to customers with overdue payments. When a company has to carry these burdens, it can use this capital to cover these sales that have been completed, but have not been paid for.

Working capital is a tool that ensures that your business will continue to operate, even when it faces a scarcity of resources to pay its basic expenses, and that’s why it’s crucial that you as a business leader know how to calculate and accumulate the working capital that’s essential for your business.

The difference between working capital and fixed investment

Despite having different functions and definitions, both working capital and fixed investment are concepts needed for the healthy operation of any type of company. Yet many managers still confuse them.

Fixed investment refers to the initial expenses needed for a business to operate, encompassing all the necessary goods such as equipment and machinery. Therefore, when a company is founded, one must estimate what fixed investment will be needed.

This should be one of the first steps of a business financial planning, even if the company already exists, since it is with this projection that all assets will be documented.

With this, it is possible to note the main difference between the two concepts, since the working capital is the monetary amounts in cash, in accounts payable and receivable, in stock or in the current account; and the fixed investment is the assets. Thus, although different, the two must be together in the financial management planning of your company.

Net working capital

Going deeper into the subject, you will find the term: net working capital (NWC). This concept refers to the amount you need to fulfill all your financial commitments in the short term.

Also known as net circulating capital, this concept is used as an indicator to manage and know all the payment capabilities of the business, allowing the management of relationships with suppliers and customers.

It is known that every type of company needs resources (money) to maintain the fluidity of its activities and, consequently, to ensure that it remains active in the market. Therefore, the NWC can be considered as a financial “slack” that allows the company and its stock to operate efficiently. In order to calculate it, it is necessary to take into account the current assets (CA) and the current liabilities (CL), which are concepts that the working capital and net working capital have in common.

Own working capital

Own working capital (OWC) is defined as the variable that indicates the amount of the company’s own resources. Therefore, it will depend on the behavior of the accounts of Shareholders’ Equity and Fixed Assets.

With this concept, the amount of the company’s own capital that is completing the current and long-term assets will be revealed. However, it should be noted that it will not strictly identify all the resources of the company.

The elements of the working capital calculation

The working capital calculation is quite simple; however, it does require some level of control of your company’s finances.

You will need some essential elements of expenses and costs to determine the minimum amount of working capital for your business. For example:

  • electricity;
  • rent;
  • staff;
  • office and cleaning supplies;
  • miscellaneous expenses such as water, telephone, internet and insurance;
  • tax forecasting;
  • expenses with ongoing services (accounting, legal counsel, management software, etc.);
  • installments of loans and financing in progress.

In summary, all expenses and costs that will happen whether or not your company receives a payment in a certain period. With this information, we will move on to the next step: the calculation.

The working capital calculation

Once all the company’s expenses have been collected, it is time to actually calculate the working capital, which is quite simple.

To illustrate, we will create a hypothetical situation for a service provider company that will determine the working capital needed for a specific year. From this, the following amounts of monthly expenses were calculated:

  • electricity: R$ 150.00;
  • rent: R$ 500.00;
  • water, telephone and internet: R$ 250.00;
  • payroll: R$ 15,000.00;
  • office and cleaning supplies: R$ 300.00;
  • tax forecasting: R$ 800.00;
  • expenses with ongoing services: R$ 1,500.00.

Thus, the amount of working capital that this company will need to remain active is R$ 18,500.00 per month.

Some companies that receive recurring payments may include such amounts in their working capital calculation in order to reduce expenses. That is, suppose that the same company receives monthly the amount of R$ 5,000.00 from some customers. In that case, it may deduct the monthly payment estimate in the calculation of its working capital. Thus, the amount would be R$ 13,500.00.

However, it is important that this payment is recurrent and guaranteed. You cannot consider for this calculation the payment of customers who are usually defaulters.

The net working capital calculation

The net working capital is the result of the amounts of current assets by those of current liabilities. So, to calculate it, just follow the formula: NWC = CA – CL.

Current assets refer to cash on hand, financial investments, accounts payable and receivable, stocks, expenses, raw materials, securities, bank deposits, bank transactions and prepaid expenses. Therefore, they are the assets and rights that can be converted into cash in the short term.

Current liabilities are all obligations that should normally be payable within one year, such as bank loans, debts to suppliers, provisions and certain accounts payable.

The own working capital calculation

Although it seems a bit more complex, the own working capital can be easily found with this formula: OWC = CA – CL – LTL.

LTL or Long-Term Liabilities are the debts that your company has that must be settled after the following financial year, which refers to a calendar year. Duplicates payable, taxes to be collected and other obligations to third parties are considered.

The working capital is an important indicator of your resources. With it, you will know the amount needed for your company to operate and grow in a healthy and linear manner.

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