Working Capital: What Is It & Why Is It Important?
In short, working capital is a metric often used by lenders to assess a small business loan applicant’s assets available to meet its current, short-term obligations.
How Do I Calculate Working Capital?
Working Capital = Total Current Business Assets minus Total Current Business Liabilities.
- Examples of Current Assets: Cash, Accounts Receivable, Inventory.
- Examples of Current Liabilities: Accounts Payable, Accrued Payroll & Other Expenses, Line of Credit Balances and Credit Card balances.
In essence, working capital is all of a small business’s liquid assets that can be used to cover its near-term expenses.
Why Do Bankers Care About Working Capital?
Working capital is a measure of a company's liquidity and its short-term financial health. If a business has positive working capital, then it should have the ability to cover all of its near-term liabilities and continue to invest and grow. If the business's current assets do not exceed its current liabilities, then it may have trouble paying back creditors.
Lenders often want to see that a business not only has the resources to repay its loan, but that it has the ability cover all of its expenses and other liabilities. "Liquidity" is important because it essentially serves as a backdrop for any short-term cash flow issues. If a business’s sales are down, or if it has any unforeseen expenses, a lender will want to see that the business has the liquid assets to cover its bills.
How Could a Lender Help A Small Business Improve Its Current Ratio?
- Small Business Line of Credit – lines of credit often have lower interest rates than credit cards. If a small business owner were to use a line of credit instead of credit cards, that might help reduce interest expense, helping current liabilities go down over time.
- Working Capital Term Loan – a working capital term loan would result in a cash infusion and help increase a small business’s current assets.
- Debt Consolidation Term Loan – a debt consolidation loan might help a small business move some of its current liabilities to long-term liabilities. This often helps decrease near-term debt obligations and ease cash flow.
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