Being an entrepreneur or a business owner, you clearly understand the importance of working capital. With excellent working capital, you can grow and take your company to the unmatched heights of success.
Working Capital, also known as the net working capital, is basically a measure of a company’s operational efficiency, liquidity, and short-term financial health. One can also say that it is the difference between organizations’ current assets and inventories of raw materials and finished goods and its current liabilities.
Business owners can proceed for working capital loans in India and make an investment in their most valuable asset which is none other than their working capital.
Table of Contents
How to calculate Working Capital?
Now, when you’ve fully understood what working capital means, it is the right time to know how to calculate the working capital requirement. Working capital is the lifeblood of any business and the simplest explanation of this fact is given in the below-mentioned formula.
Working Capital (WC) = Current Assets – Current Liabilities
- In other words, you can say that working capital is the number of assets available to pay off your short term expenses. So, to calculate working capital, you can compare the company’s current assets to the company’s current liabilities.
- Now, current assets include cash, inventory, accounts receivable, and other assets that are expected to turn into cash in less than one year.
- Current liabilities are taxes payable, accounts payable, current portion of long-term debts, and wages.
- Now, it is important to know the fact that working capital that is in line with or higher than the industry average for a company of comparable size is usually considered as acceptable or positive working capital as low working capital includes the risk of default or distress.
- Negative working capital or low working capital in which business owners have more current liabilities than cash assets in the year-end is generally considered as the huge red flag to the investors. This figure of negative working capital basically indicates that you may not be able to pay your creditors and finally end up with bankruptcy sooner rather than later.
- These WC numbers play a crucial role while applying for working capital loans as when investors look at these figures, they foresee financial difficulties that may lie over the horizon.
- Business owners can easily calculate their working capital needs by using the free working capital calculator. This calculator assists you in determining working capital needs for the next year so that you can make a budget accordingly.
If you’re looking for working capital finance then head towards ZipLoan and get your loan application process soon. ZipLoan will disburse the loan in just 3 days and require the least documentation such as:
- PAN card
- Proof of house address or business address
- Bank statement of previous 9 months and previous 2 years of ITR copy
What is Working Capital Deficit?
While discussing working capital and net working capital requirements, how could one forget about mentioning Working Capital Deficit?
- Working Capital Deficit or working capital deficiency is the situation happens when your current assets are less than your current liabilities and this situation is also known as negative working capital.
- Look, to maintain the flow of the business, it is important to have healthy assets and profitability and thus, situation occurs when you have a serious cash flow problem especially when assets are not turning into usable cash.
- This operating liquidity is essential to pay your short-term debts and day-to-day operational expenses if your company is going to stay in business.
- Working capital deficit is not faced by small and medium sized businesses but also by the large companies with enough assets. Large companies can also collapse when they couldn’t generate enough usable capital to sustain their business and pay debts on time. Check out these conditions before opting for working capital finance in India.
Methods of Calculating Working Capital Requirement
There are three methods to calculate working capital requirement namely – Percentage of Sales method, Regressions Analysis Method and Operating Cycle Method.
#1. Percentage of Sales Method: It is one of the easiest and traditional methods to calculate working capital. This method is basically based on the principal of ‘history repeats itself’.
For estimating working capital requirement in this method, business owners check the relationship between sales and working capital for the last 5 years.
The advantage of this method is that it is very simple to understand and determine working capital requirement for the company.However, it comes with disadvantages as well.
As this method is based on assumptions and previous year relationship between sales and working capital, it may be possible that assumption may not work out this year and whole calculation goes wrong. Also, this method is not applicable on startups because they have no past.
#2. Regression Analysis Method: The next method of calculating working capital requirement is regression analysis method which tries to establish trend relationship. This method basically connects revenue with working capital in the form of equation, i.e., Working Capital = Intercept + Slope*Revenue.
Here, the intercept is the point where regression and working capital axis meet and slope is the rate of change of working capital with one unit change of revenue.
#3. Operating Cycle Method: Out of 3, this is the best and ideal method to determine working capital requirements for the company as it considers actual business and industry situation while considering working capital requirement. The formula used here to calculate the working capital loan is:
Working Capital = Cost of goods sold*(Number of days of operating cycle/ 365) + Bank and Cash Balance
It works on the fact that the longer is the working capital operating cycle, higher would be the requirement of the working capital.
It is important to estimate the working capital requirements so as to apply for a working capital loan. If you are searching for the loans ranges from Rs 1 Lakh to Rs 5 Lakhs, then consider ZipLoan as they offer easy loans with minimal eligibility criteria.