Working capital is a crucial aspect of the financial health of your small business. It can show how well you can manage your business expenses and operations. But you may wonder what makes it so important in small business financial management. 

This guide discusses the importance of working capital in financial management, including:

  • What is working capital?
  • How does it affect your financial management?
  • How can you calculate and improve it? 

What is working capital? 

Working capital is how much money your business has to cover necessary operations and put towards growth. This money could include available cash or assets that you could easily convert into cash. Knowing your working capital helps you understand your business’s overall worth. It also shows how much money you have to pay for necessary expenses. 

Positive working capital means you have more cash assets than liabilities or money that your business owes. If this is true for your business, you can invest in growth. But, negative working capital means you may struggle to pay off loans and expenses, which could seriously hurt your business’s financial health. 

How does working capital affect your financial management?

Knowing the importance of working capital in financial management is useful because it can show you why you need to track and maintain it. There are a few things that make working capital so crucial to your small businesses financial health. 

Helps meet short-term financial obligations 

Working capital allows you to reliably pay off short-term liabilities like business expenses and credit or loan payments. Without this capital, you may struggle to meet these short-term obligations and increase your business’s debt. 

Strong working capital means you can have sufficient cash flow, which is the money coming in and out of your business over a given time. Even if your business is profitable, you may overspend your earnings in the short term, so you run out of the cash you need. 

Managing your working capital enables you to put that cash in the right place when need be. Also, if you experience an unexpected expense, you’ll have the cash to cover it.  

Helps make business decisions 

Managing your working capital can also show you how you operate your business financially. If you understand how much working capital you have, this clarity will help you know when to spend more or less on your business.  

Low working capital might suggest it’s a good time to reduce spending and focus on improving your profits. Being aware of it will help you know when to alter your business operations. Alternatively, when your financial health is good, you analyse what you did right. Plus, high liquidity could be the best time to invest in growth,  

Improves business value 

Since your working capital shows your business financial health, it can also help you understand your business value. With high working capital, you have excess cash and convertible assets with lower liabilities. This ability to convert assets to cash increases your worth. As a result, you have strong business value, which looks good to investors or loan servicers. 

Positive working capital makes your business appear less risky and more reliable because you don’t struggle to cover expenses. Knowing your worth is useful if you plan to insure or sell your business. 

Helps for growth planning 

Another reason working capital is important to your business financial management is that it can show you when to invest in growth. For example, you have excess cash for product development, new locations, or marketing when you have positive working capital. 

How can you calculate and improve your working capital? 

Once you understand the importance of working capital in financial management, you may want to look into yours to see how you can improve it. 

Calculating working capital

To calculate your working capital, you’ll need the financial data found on your balance sheet. You can use this to add up your assets and liabilities. Then, working capital equals your current assets subtracted by your current liabilities. 

You can find our more detailed guide on calculating working capital here. 

Improving your working capital

Focusing on your working capital can give your business a stronger backbone for financial reliability. To improve your working capital, look at your current assets. Growing assets that you can easily convert into cash can help you strengthen your working capital. 

To increase your cash, consider focusing on business sales to earn greater profits. Then, ensure that you convert those sales to cash quickly by establishing an invoicing system with incentives for quick payment. You can also remind customers by kindly following up on late payments.

If your current liabilities drag down your working capital, try to reduce them. First, cut out any unnecessary expenses that aren’t helping your business. Then analyse your operations to see what you find more affordable options for or can do yourself instead of outsourcing. 

To manage necessary payments, try budgeting your money to cover them when you need to. For example, if you plan for taxes in advance, you can avoid surprises that you struggle to pay for.

Aside from increasing assets and decreasing liabilities, you may want to start setting money aside for an emergency fund. Saving can improve your working capital and prepare you for unexpected expenses that could hurt your business financially. If you plan for these things, you can work towards good working capital and better value.

Save time on financial management with Countingup

The best way to better manage your working capital is through strong financial organisation. You can better track your assets and liabilities and focus on your profits to enhance your working capital with the right accounting software. Plus, you can analyse your business finances to improve them in the long run and support your performance. 

Financial management can be stressful and time-consuming when you’re self-employed. That’s why thousands of business owners use the Countingup app to make their financial admin easier. 

Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward! 

Find out more here.

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