What is working capital?
If you ask your accountant, they will probably describe it in a simple equation: working capital is current assets minus current liabilities. Working capital is quite straightforward, once you understand what it’s all about.
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. What have you got left? That’s your working capital. 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; and
- 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.
What does this mean day-to-day?
Ultimately, working capital comes down to whether you’d be prepared if you came up against a roadblock tomorrow. Working capital is vital because your business may not be able to run if your kitchen equipment is out-of-order, the truck breaks down, or a growth opportunity comes your way and you can’t take advantage of it. It’s virtually impossible to predict these occurrences every time, so having money in the bank as a buffer is essential.
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!
Nicki is the Senior Working Capital Product Specialist at Valiant. Nicki has impressed hundreds of Australian SMEs, working closely with business owners to achieve successful outcomes for their business.