If you’re a small business owner, you may have come across the term, “working capital.” But what is working capital? And what do companies mean when they say they provide working capital?
The definition of working capital
Working capital is defined as your current assets minus your current liabilities. This means you may have positive or negative working capital, depending on how much debt you have.
Assets to include when calculating your working capital are your income and inventory, for example. Basically, you should factor in cash or anything that can quickly be converted to cash. Liabilities would include things like your accounts payable, wages, or any debt due within one year.
Note that positive working capital is not always a good thing. It may mean you’re not investing enough of your excess capital. To figure out if you’re working capital is too high or too low, calculate your “current ratio.”
The current ratio is your current assets divided by your current liabilities. You want this to be around 2. If your current ratio is lower than 2, you may not be able to pay off your liabilities.
Working capital loans
When companies provide working capital—through a business loan, merchant cash advance, or other financial product—they are offering cash to use for everyday expenses and operation.
For instance, an inventory loan could be used to purchase merchandise, or you could use a business loan to pay bills, develop products, or buy tools and equipment—just about anything.