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 elements that go into the calculation of working capital
Calculating working capital is very simple, but it does require a certain level of control over your company’s finances.
You need to have a few essential elements in terms of your costs and expenses to determine the minimum amount of working capital that you need for your business, such as:
- Construction and cleaning materials;
- Various expenses such as: water, telecommunications, the internet and insurance;
- Expected taxes;
- Expenses derived from continuous services (accounting, legal services, management software, etc.)
- Active installment payments for loans and financing.
Basically it includes all of the costs and expenses that will take place whether you receive payments or not during a given period.
Armed with this information, let’s move on to the next step, the calculation.
The calculation of working capital
Once all the current expenses of the company have been identified, it’s time to calculate its effective working capital, which is very easily done.
For illustrative purposes, let’s create a hypothetical company that provides services and that needs to determine its working capital for a specific year. To do this, the following monthly expenses have been identified:
- Electricity: $ 150.00
- Rent: $ 500.00
- Water, telecommunications and the internet: $ 250.00
- Payroll: $ 15,000.00
- Office and cleaning materials: $ 300.00
- Expected taxes: $ 800.00
- Spending on continuous services: $ 1,500.00
Thus, the size of the company’s working capital to remain afloat is $ 18,500.00 a month.
Some companies that receive regular payments can insert these values into their working capital calculation to reduce its size. Thus, let’s suppose that this same company receives 5,000.00 in total each month from a few clients.
In this case, we can deduct this figure from the total working capital to arrive at a final value of $ 13,500.00.
However, it’s important to make sure that these regular payments are really guaranteed. You can’t consider receiving money from clients who are usually late in their payments.