Capital is the lifeblood for any company. Without it, a business won’t ever grow or move forward. The idea is to go from a startup to something much bigger. That requires capital. Not just capital though, you need to understand how it works so that when the time comes, you can make the right decisions for your business.
What Is Working Capital?
To explain it simply, working capital is the money your company needs to operate, in order to cover basic expenses like employee payroll and inventory. Also, you may need to carry accounts receivable because some of your customers haven’t paid their bills yet. That’s where your working capital comes in. You don’t wait to be broke while you wait around for those bills to be paid.
You can assess your working capital by dividing your assets by your liabilities. If your assets are higher than your liabilities, that means you have a positive cash flow. However, if your ratio is at a 1:1 for example, this means your assets and liabilities are equal. You are paying your bills but you aren’t making any money.
If you’ve got a negative ratio, you’re paying out more than you bring in. A business cannot sustain a negative ratio for a very long time, it will eventually put you out of business. In order to be successful, you need enough money to pay your bills while having money left over to set aside for savings and investing back into the business.
Now, this may seem strange to you but just as you don’t want your working capital ratio to be low, you also don’t want it to be too high. A ratio of over 2:1 means that you are not investing enough into your business. It means your business is making a lot of money but you aren’t doing anything with that money to grow. If you can keep a ratio between 1.2 and 2, you will be in the prime area that creditors look for, making you more attractive for funding and possibly keeping your business alive.
How Much Working Capital Do You Need?
Well, let’s start by addressing the difference between working capital and growth capital. Working capital is the money your company needs to stay afloat. To pay your employees, pay your bills, stock inventory, etc. Growth capital is more about the long term. The money that will be used when your business plans to make major changes like an expansion or new location. This is why you should always keep your working capital and growth capital separate.
Okay, now that we’ve covered that. You need at least enough working capital to avoid having to cut into your growth capital for basic business needs and expenses. If you are using growth capital to cover working capital expenses than you are obviously in need of more working capital. Your company can never grow if you continue to use your growth capital for normal business expenses. Your working capital needs to be at least at a 1:1 ratio, preferably a bit higher for safe keeping. Taking slow steps to developing a good balance of working capital and growth capital will pay off in the long run. Rushing into your dreams will only end in heartbreak. Working capital needs to be maintained in order for your growth capital to do its job. So with good a working capital ratio and patience, your company can expand and develop organically into a successful business.
Working With Sprout
Sprout is an online marketplace where businesses come to compare and save on small business loans. You go to www.SproutLending.com and simply fill out a profile or call us at 800-865-6057. Based on that information you provided, Sprout suggests the best matches depending on the amount and purpose of the business loan you are seeking. Last year, Sprout and it’s staff was responsible for over $100 million in loan approvals.
