Increase Working Capital to Grow Your Business

Working capital is the amount of money a business has on hand to pay short-term bills, such as inventory purchases. It’s one of the most important financial figures in any business, because not having enough working capital is often a precursor to bankruptcy. Even a profitable business can become insolvent if its working capital is insufficient.

Growing companies in particular need to keep an eye on working capital, because their needs may change as liabilities are incurred to fund growth. And all companies that have or plan to seek financing must have a handle on working capital, as it’s a figure closely watched by potential lenders and investors. Adequate working capital is what allows entrepreneurs to rest soundly at night, knowing they have enough money on hand to pay bills the next day.

Determining working capital is easy. It requires only two figures from the balance sheet: current assets and current liabilities. The current assets figure is found on the top line of the balance sheet. It consists of cash, inventory, accounts receivable, marketable securities, and other assets that could be turned into cash in less than a year. Current liabilities consist of accounts payable that must be settled in cash within a year, such as supplier payments, taxes, and payments on long-term debts.

Subtracting current liabilities from current assets gives you working capital. So a business that has $10,000 in current assets and $6,000 in current liabilities has $4,000 in working capital.

It’s a little more complicated to figure out whether a business has sufficient working capital on hand. To come up with this answer, it takes two more figures: planned growth rate and target current ratio. The growth rate is the percentage by which the business anticipates its sales will increase over the next 12 months. For this example, assume a planned growth rate of 25 percent.

A business’s current ratio is figured by dividing current assets by current liabilities. This ratio is closely examined by bankers, partners, suppliers, and others evaluating a business’s stability and prospects. A current ratio of 2 or more, indicating current assets are at least twice current liabilities, is a target for many businesses and for institutions that lend to businesses.

Different businesses and industries, however, have their own working capital needs. Restaurants, for example, sell on a cash basis and turn over inventory rapidly, so they need less working capital than other types of businesses. Manufacturers of heavy equipment, on the other hand, offer credit terms to customers and turn over inventory more slowly, so they’re more capital-intensive.

Online calculators can help you determine your working capital needs today and in the future. The above example, with $10,000 in current assets and $6,000 in current liabilities, indicates a current ratio of 1.67. To reach the desired current ratio of 2, you’d need to add $2,000 in working capital.

You can also use similar calculators to figure out how much you’ll need to increase working capital to provide enough for planned future growth. In this example, with an annual sales growth rate of 25 percent, the amount of working capital required would grow to $7,500 in a year.

There are many ways to increase working capital, including obtaining a bank loan or line of credit, or factoring your receivables. Before you start your search for capital, it’s important to know how much you’ll need to borrow to meet target current ratios in planned growth scenarios. Another way to increase working capital is to delay paying bills by negotiating longer payment terms from suppliers. Finally, you can accelerate accounts receivable, shortening the time you give your customers to pay you.

All these methods can be useful, but some, like bank loans and factoring, also increase risk. So only increase working capital when you need to, such as when you plan to grow, and only increase it by the amount you plan to grow.

Mark Henricks writes about business, technology, personal finance, and other topics from Austin, Texas. His work has appeared in The Wall Street Journal, Entrepreneur magazine, The Washington Post, and other leading publications.