calculate net working capital

How to Calculate Net Working Capital to Know Your Business’s Liquidity?

July 21, 2022 • 218 views
Author: PoonawallaFincorp Category: Business Loan

Working capital is essential for any business. This is because businesses need money to meet their short-term expenses. Some of these expenses include money to pay for raw materials, money to compensate employees, and money to pay for utilities and rent.  
If you feel that your business does not have enough working capital to operate smoothly, then you can opt for a Working Capital Loan in India. It is a type of Business Loan that is specifically meant to facilitate the working capital requirements of a business.  
If you’re not sure about how to calculate the net working capital of your business to know its liquidity, we’ve got you covered.  

What are Current Assets?  -

Items on your balance sheet which can be converted into cash within a year are known as current assets. Cash and cash equivalents (such as money market funds, commercial paper, treasury bills, etc.) are examples of current assets.  
Essentially, current assets are those assets that can be used to pay for your business’s operating expenditures.  

  • Cash and Cash Equivalents – This includes any liquifiable investments of the business. For example, if a business has invested in stocks of a publicly-traded company, then it counts as a cash equivalent.  
  • Inventory – This includes all the goods that a business owns that have not been sold yet. It also includes any raw materials and partially assembled goods.  
  • Accounts receivable – This entails all the money that is due to come into the business. For example, if inventory has been sold on credit and the dues are going to be repaid within the year, then that counts as accounts receivable.  

Suppose your business has cash worth ?24 Lakhs and inventory worth 60 Lakhs. This means that you have current assets worth ?84 Lakhs (?24 Lakhs + ?60 Lakhs.)  

What are Current Liabilities?  -

Current liabilities are those items on your balance sheet that need to be paid for within one year. Some examples of current liabilities include debt payable, payable accounts, employee salaries, and so on.  
Essentially, current liabilities are your short-term financial obligations.  

  • Payable salaries – Usually this is the biggest current liability of a small to medium-sized business. The wages that need to be paid to employees within one year are included as current liabilities.  
  • Accounts payable – This means any money that needs to be paid to vendors, utility services, rent for office space, any taxes, and so on.  
  • Debts payable – This includes any debt repayment that needs to be made within the space of one year. If you have long-term debt but some installments need to be repaid within the year, then that counts as a current liability as well.  

If you need to pay ?30 Lakhs every year to your employees and you have an annual debt of ?15 Lakhs, then your current liabilities are ?45 Lakhs (?30 Lakhs + ?15 Lakhs).  

How to Calculate Net Working Capital?   -

Your net working capital is your current assets minus your current liabilities. Hence, from the above example, your net working capital would be ?84 Lakhs (current assets) – ?45 Lakhs (current liabilities) = ?39 Lakhs (net working capital).  

Why is it Crucial for a Business?  -

A positive net working capital indicates that a business has enough money to meet its short-term expenses. It is an indicator of the solvency of a business. If a business has negative working capital, then it means that the business will need to raise money through funding or acquire debt to meet its expenses.  
If you have a negative net working capital or if you foresee that you will have negative net working capital in the future, then a good option to stay solvent is to avail a Working Capital Loan.  
A Working Capital Loan in India is tailor-made to meet working capital requirements. You do not have to provide any security or collateral to avail such a loan. Further, you can take advantage of flexible loan repayment tenures which suit your business plan.  

How to Increase Net Working Capital  -

If you’re looking to increase your net working capital, then these tips might help.  

Also Read: How Business Loans Take Your Business Higher?

Unload Long-Term Assets for Cash  -

Long-term assets do not count as current assets. This is because the value of these assets is spread out over a period of more than one year.  
You may have long-term assets that are not being used. Suppose you have machinery that needs to be repaired and isn’t being used. You can have such machinery repaired and then sold for cash. This cash will then count towards your current assets increasing your liquidity. 

Refinance Your Debt  -

Debt can account for a large portion of your current liabilities. A business may have lots of short-term debt such as credit card payments and lines of credit. It is possible to refinance such debt and turn them into longer-term debt. For example, you can take out a Business Loan which can help you repay your short-term debt such as credit card debt (which is usually payable every month).  
Refinancing can help to ensure that you have fewer debt repayments that are due within one year. Hence, it can help you increase the liquidity of your business.  

Sell Excess Inventory  -

A business may find itself in a position where it has a lot of excess inventory. You can review your inventory to find items that can be sold in the short term. Even though inventory counts as a current asset, it is still not as liquid as cash. This is because selling inventory can be more difficult than spending cash.  
So, if you find that you have excess inventory, then selling such inventory for a discount can help you meet short-term financial requirements.  

Wrapping Up -

Essentially, net working capital measures the ability of a company to meet its short-term financial obligations. If a company has excess working capital, then it means that it can not only meet its finances but also invest in its growth. However, a business should not have too much working capital because that can be an indicator that a business has a lot of excess inventory or is not investing its excess cash properly.  
If you calculate net working capital and find that your working capital is falling short, then consider taking out a flexible Working Capital Loan in India to help you meet your obligations.


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