Business owners are concerned about their bottom line. Naturally, they are looking to generate a profit on their income statement. However, to stay in business in the long term, companies must also weather short-term cash fluctuations. This requires sufficient working capital to stay solvent throughout the year.
What Is Working Capital?
Working capital is the money your company needs to finance daily operations. Businesses have to pay rent, utilities, and other expenses related to keeping their doors open. They must make payroll, and they also have to have sufficient funds to order goods or raw materials from their suppliers. All of this requires cash or working capital.
The money to pay for operating expenses comes from the profits the company generates. The only problem is that your customers or clients may not pay you as soon you invoice them. In fact, they could have payment terms that allow them to pay you 90 days after they receive the goods. During that time, your company must still pay the current expenses to keep generating more profit.
Components of Working Capital
The amount of working capital is the difference between your current assets and your current liabilities. For individuals, it’s about how much money they have in the bank to pay their current bills. For a business, it’s a little more complicated. You must understand what type of assets and liabilities you have, and whether they can cover your cash needs. Here are some examples of current assets:
- Short-term investments and advances
- Prepaid expenses
- Inventory of raw materials, work-in-progress, and finished goods
On the other hand, you have current liabilities, which are expenses that must be paid during this inventory cycle. Here is a list of some of these liabilities:
- Invoices for goods or raw materials
- Outstanding expenses
- Short-term debt
- Taxes or dividends
It’s important to understand the timing of your cash flow. It’s not enough to turn a profit at the end of the current operating cycle, but you must also be able to meet your company’s cash needs for current liabilities when they’re due.
What You Need to Know
It’s not a bad idea to have a complete financial picture for the full accounting year to ensure that your assets will exceed your liabilities. However, it’s even more important to understand your payment cycles. For example, how long does it take until you get paid after you send an invoice? How long does it take from the time you order raw materials until you can sell them? This will help you understand and meet your cash needs. And that’s why it’s important to think about working capital for your business in Columbus, GA.