How Much Working Capital Does a Small Business Need – Key Considerations

Having adequate working capital is necessary for businesses of all sizes and types. The same helps companies grow, expand, and carry out their day-to-day operations. And assessing this working capital can help businesses in a variety of ways. For instance, it can come in handy in inventory management, liquidity optimisation, financial management, and more. But how do you assess working capital for your small business? Well, continue reading as we delve deep into working capital requirements, factors essential for its assessment, working capital loans, and much more. 

Here are a few factors to consider while assessing working capital needs for small businesses.

Business Cycle

When it comes to working capital, assessing the business stage or cycle is important. For example, businesses in their growing stage have increased requirements for working capital. The same happens because of the increased financial requirements to boost sales, marketing, and more. Alternatively, when struggling financially, businesses might need to cut down their working capital. 

Business Model

One of the key factors that affect working capital requirements is also the nature of the model of the business. This means different industries have different working capital requirements. For example, manufacturing enterprises have increased working capital requirements for successful inventory management and other purposes. 

Growth Plans and Stage

As mentioned earlier, the business cycle plays a crucial role in affecting the working capital requirement of businesses. This means companies planning to grow or expand extensively will automatically require more working capital to increase production and sales, add inventory, and do much more. 

Additional Factors

In addition to these, several other factors also influence a company’s working capital requirements. This includes factors like credit terms, market conditions, seasonality, business sales, and so on. 

Managing Working Capital Financing

Whether you’re struggling with cash flow concerns or you simply need some extra cash, working capital financing may help. Still thinking how? Well, with working capital financing, businesses may fulfil their short-term capital needs and obligations. The same can also be used to grow or expand your business. 

 There are several benefits of working capital financing. For example, they are easy and quick, they can be availed even with no collateral, and can positively impact your turnover ratio. 

Working Capital Loan

Working capital financing can be availed using several methods. One of the most popular and preferred types of working capital financing is working capital loans. 

Working capital loans can be simply understood as loans taken by businesses to finance their day-to-day needs. For example, a company may avail of these loans to cover expenses like rent, payrolls, clearance of debt, and more. These can come in handy if businesses are facing some type of crunch and are struggling with adequate capital in hand. 

Determining Working Capital Needs for Small Business

Determining your working capital needs can help you understand your cash flow. This way you can better plan your business expansions and daily operations. 

Here is a simple formula that can be used to determine or calculate working capital requirements for your business. 

Working Capital = Current Assets – Current Liabilities 

Here, current assets are simply a business’s resources, one that showcases a company’s positive advantage that can be claimed over the coming 12 months. Some common elements of current assets are cash, accounts receivable, notes receivable, inventory, stocks, etc. 

Alternatively, current liabilities are the debts of a company. Payrolls, payable tax, accounts payable, and dividends are some of the common elements of current liabilities. 

How Much Working Capital Do I Need for My Small Business?

The exact working capital requirement for your business depends on a variety of factors, like its size, type, operating cycle, and more. For example, if you’re trying to restock or increase your inventory, your working capital requirements may be comparatively higher. 

However, a working capital ratio ranging between 1.5 and 2 is considered to be okay for small businesses.³ The same ensures small businesses have enough to clear their liabilities with some amount left for crucial purposes. Also, it is very important to ensure businesses maintain a positive working capital ratio. 

How Do You Figure Out Your Required Working Capital?

As mentioned, figuring out your working capital requirements can help businesses maintain their cash flow and much more. Businesses may use two different formulas to figure out their required working capital, including the formula for working capital and working capital ratio. 

To estimate your working capital requirement using any of these formulas, you must have a list prepared of your current assets and liabilities. 

What Are Some Factors I Should Consider When Estimating My Working Capital Needs?

Now that you know the formula for estimating working capital needs, is there something else that you need to know? Well, yes. Considering a few factors when calculating your working capital requirements may give you better estimates. Here are some of them. 

• Cash Flow Cycles

A cash flow cycle is a simple calculation that estimates the time taken by your business to convert inventory into cash. This means businesses with shorter cash flow cycles may manage. However, longer cash flow cycles mean that businesses need more working capital while waiting for their consumer transactions. 

• Growth Plans

Thinking of expanding your business? Well, consider adding the same to your working capital needs. You might be applying for loans and doing much more to ensure liquidity flow and smooth daily operations. 

• Short-term Financial Needs

Estimating your short-term needs like accounts payable, payrolls, and more can give you a more accurate figure on your business’s working capital needs for your business to keep going. 

• Business Seasonality 

Considering the seasonality of your business is also important. This means if you have a seasonal business, your working capital needs might increase during the festive period. However, that might not be the case and it can be lowered during slow periods. 

Why Is Having Enough Working Capital Important?

Understand your working capital as your budget. Just like how you need a monthly budget to run a house, you need a working capital to run a business smoothly. With enough and adequate working capital, a business ensures its preparation for anything and everything. Be it seizing Market opportunities, plans to grow, covering unplanned expenses, or anything else, having enough working capital can help you overcome all these hurdles easily. 

Think of it as financial security ensuring your business’s stability in an ever-changing market landscape and unexpected scenarios. 

How Can I Increase My Working Capital?

Having a positive working capital showcases your business’s strong financial stance. This also means the value of your current assets is higher than your liabilities. 

Here are some easy and effective things to do to increase your business’s working capital and make it turn positive. 

• Make sure to manage your inventory effectively. 
• Try refinancing your debts. Consider factors like interest rate, terms and conditions of your loans, etc. 
• Try negotiating with your vendors and ask for better discounts and deals. 

Working Capital Ratio Formula

The working capital ratio can be calculated using a simple formula. 

Working capital ratio = Current assets ÷ Current liabilities. 

This formula can help you determine your company’s financial wellness and Liquidity. 

Working Capital Formula

You can also easily calculate your working capital using the following formula. 

Working capital = Current assets – Current Liabilities