Here's what working capital can do for your business

Managing the financial health of your business is crucial, and one of the key metrics that can help you maintain stability is working capital. It acts as a safety net, ensuring you have enough funds to cover everyday expenses while also positioning you for growth. But what exactly is it, and how can it benefit your business in both the short and long term? Let us explain.

What is working capital?

In its simplest form, working capital is what’s left after you’ve tallied up your short term assets and subtracted your short term debts. It’s the money that is available to pay for immediate expenses, should you need it. These expenses could include:

• Any wages you need to pay employees for additional hours;
• Repairs to any equipment, such as fixing a broken fridge;
• Purchasing more supplies when stocks are low;
• Unexpected purchases you may need to make.

At a high level, working capital is an indicator of how efficiently a business is operating. It’s a measure of short-term health. By looking at current assets and liabilities, you can gauge whether a business is being managed effectively.

How do you calculate working capital?

The formula for working capital is simple: current assets minus current liabilities. Assets can be cash, accounts receivable, and inventory, while liabilities include accounts payable, short-term debt, and payroll.

The role of working capital in your business

From everyday operations to growth strategies and long-term business plans, having enough working capital is key to keeping your business running smoothly and covering expenses as they come. It can help you:

Manage day-to-day operations

Working capital is the backbone of your business's regular operations, helping to ensure you can cover costs like salaries, rent, and utilities, all without delay. It helps you maintain healthy cash flow, working as a financial buffer you can tap into to meet short-term obligations while waiting for customer payments. Plus, it allows you to buy the raw materials you need to keep production going without delays. In a nutshell, working capital helps your business stay in business.

Drive business growth

If you're thinking about expanding, whether to a new location or into a new market, you need to make sure you have enough capital—because the truth is, growth requires investment. Working capital provides you with the necessary resources to fund initiatives like opening a new location, creating a new product line, or hiring more employees.

It also gives you flexibility to jump on time-sensitive opportunities—like buying extra inventory at a discounted price—and allows you to supercharge your marketing efforts which, done right, should help grow your customer base.

Cover unexpected costs

At one point or another, every single business faces unforeseen costs—whether that's because a piece of equipment suddenly stops working or a quality control issue leads to product recalls. This can be a great source of stress and financial strain, but a solid working capital reserve can help absorb these costs without having to cut essential expenses.

Manage seasonal variations

Most businesses experience seasonal variations. For example, retail businesses often see a significant increase in sales during the holiday season and hotels in beach destinations see an influx of bookings during summer months. Working capital can help meet the high demands of peak seasons, even if you need to purchase more inventory or hire casual staff.

The opposite is also true: working capital can help you navigate slower periods. If you own a construction business in a region with harsh winter conditions that force you to slow down activity, managing your working capital efficiently allows you to create reserves to sustain you during these periods.

Improve creditworthiness

Both lenders and investors look at your working capital as a way to assess your business's financial healt. Having a solid balance can improve your creditworthiness, which in turn can help:

• Access business loans with more favourable terms: Strong working capital is a green flag for lenders, as it indicates you'll be able to meet repayments on time. This lowers the risk incurred by the lender and can give you access to better loan terms, such as lower interest rates or longer repayment periods.
• Secure investor interest: For investors, having a healthy working capital position says your business is well-managed and financially stable.
• Create strong relationships with your suppliers. Having enough cash flow to pay suppliers on time helps you build trust and reliability. In the long, this may even lead to discounts or extended payment terms.

Ways to improve your business's working capital

Speed up accounts receivable

In other words, find ways to receive payments on time. One must-do here is create a clear credit policy and communicate it with your customers from the get-go, so you can set expectations early on and keep everyone accountable for their payments. But there are other strategies you can implement, including:

• Sending your invoices immediately after delivering the product or service
• Using an automated follow-up system (rather than having to do it manually)
• Using a digital invoicing tool for a more streamlined process
• Shortening payment terms
• Offering early payment discounts
• Offering flexible payment plans for customers struggling to pay the full cost upfront
• Accepting multiple payment methods (such as credit cards, bank transfers, or online payments)

Cut operational expenses

Some expenses are nice-to-have's, not necessarily must-have's. If you're struggling to maintaining healthy working capital, these should be the first to go. We're talking unnecessary software subscriptions, regular catered lunches, excess inventory that just doesn't sell, or even underutilised office space.

Take the time, as well, to go through your processes and workflows to see if there are ways you can optimise them further. Could you renegotiate a supplier contract? Or outsource certain non-core functions? You may find ways to save money you'd never even consider.

Manage your inventory efficiently

Keeping a close eye on your inventory is key to avoiding waste, both in money and the product itself. Identify slow-moving products and find ways to sell them, whether that's by lowering the price or bundling them with other items. Make sure to reduce your orders of these products, if you know they're not selling well.

Additionally, avoid overstocking by using an inventory management tool that helps you forecast demand and plan accordingly.

Find new ways of boosting sales

Innovation is key and there are always new avenues to explore in order to increase revenue. A few ideas:

• Target a new customer audience
• Start selling online, on top of your physical store
• Expand your product or service offering
• Upsell and/or cross-sell relevant products
• Create a sense of urgency with limited-time discounts
• Implement a loyalty program to encourage repeat customers
• Leverage digital marketing—run social media campaigns, work with influencers, or create a newsletter, for example
• Review your sales funnel, pinpoint where you may be losing potential customers, and make improvements accordingly

Apply for a business loan

The right loan can help fund most purposes, keeping your cash flow healthy and allowing you to jump on opportunities when they come up. A few options to consider include:

• Unsecured business loan: Lets you borrow money without collateral like property or equipment. A flexible option for needs like cash flow, equipment purchases, or growth opportunities.
• Business line of credit: A flexible way to borrow money for your business, giving you access to funds up to a set limit, and you only pay interest on what you use.
• Invoice finance: Helps businesses access cash from unpaid invoices quickly, using accounts receivable as collateral.

Things to keep in mind

It may sound counterintuitive to everything we’ve just spoken about, but having too much working capital isn’t always a good thing.

If you have too much money tied up in working capital, you may be missing out on using the money for other things. For instance, perhaps the excess money would be better invested in a refurbishment, redecoration or hiring a new employee, rather than just sitting in the account.

Balance is key, so have a chat with your accountant about the amount of working capital that is healthy in your industry and for your specific business. Don’t leave these key decisions to chance!