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Business Owner’s Guide to Understanding Working Capital Management

As a business owner, do you constantly worry about having enough cash to cover your expenses? Are you curious how understanding working capital can help you plan and strategize for the future? Working capital is the lifeblood of any business, and understanding it is crucial for the success of your company.  Without adequate working capital, a business can struggle to pay suppliers, meet payroll, and invest in growth opportunities. At Brady CFO, we can help you navigate the complexities of working capital to ensure your company is set up for success now and in the future. Keep reading to explore working capital management, or skip ahead to find the most prominent information for your business.

In This Article:

  • What Is Working Capital for a Business?
  • Why Is Working Capital Important?
  • How Is Working Capital Calculated?
  • Why Is Working Capital Management Important?
  • How Do You Fix Underwater Working Capital?
  • Get a 100% Risk-Free Financial Clarity Assessment from Brady CFO

FAQs for Understanding Working Capital

As a business owner managing $1-30mil in annual revenue, understanding working capital–what it is, why it’s important, and what to do if it’s not where you need it to be–is essential for long-term sustainability and growth.

What Is Working Capital for a Business?

Working capital is the measure of a company’s short-term financial health and liquidity. It is the difference between a company’s current assets and its current liabilities. In simpler terms, it represents the funds a company has available to run its day-to-day operations.

How Is Working Capital Calculated?

Having sufficient working capital is essential for a business as it enables them to pay their bills, purchase inventory, and cover expenses without relying on external financing. A positive working capital indicates that a company can meet its short-term obligations with ease, while a negative working capital may indicate financial distress.

How Is Working Capital Calculated?

Working Capital is Current Assets minus Current Liabilities.
  • Current Assets: (Cash, AR, Prepaid Expenses, Inventory). Think “liquid assets that are either cash or can be easily converted into cash.”
  • Current Liabilities: Amounts due (including current amounts on long-term debt) within the next 365 days (or less). 
You never want to be underwater on your working capital (have fewer current assets than current liabilities). This is really bad and represents concerns in your business operations. Ultimately, it means you don’t have enough liquid assets to pay all your immediate bills.

Why Is Working Capital Management Important?

You want to prevent yourself from ever getting into an underwater working capital position. You can do this by regularly evaluating your working capital position once a month. You also want to be careful to watch the following:
  • Paying cash vs financing for long-term assets – this will deplete your current assets.
  • Paying too much in distributions to ownership – again, this will deplete your current assets.
  • Having low or negative operating margins – this will not add enough cash back to your current assets as you grow.
Underwater working capital shows a bank that you don’t know how to manage your business without putting yourself in a bad liquidity position. And if you already have a lot of other debt in the company and don’t have assets to refinance, you will struggle to obtain any help from the bank, as you will be considered too risky.
The only way to fix this is to 1) quickly churn a lot more high-margin sales and inject your business with cash or 2) obtain long-term financing with the help of a Fractional CFO who can paint a positive picture of your company to lenders.

How Do You Fix Underwater Working Capital?

Most entrepreneurs are highly optimistic. However, reality is a stark difference from over-opportunistic thinking. If we all had a magic bullet to churn more high-margin sales quickly, we would kill for it. But tested business owners know that this isn’t how things work. While improving margins is possible, the approach to rebuilding your working capital position has a long-term outlook. It takes time to grow sales and improve margins. Obtaining long-term financing is a potential quick fix. Suppose you don’t already have a lot of long-term debt. In that case, you can potentially refinance some of the long-term assets on your balance sheet (equipment, buildings, etc.) and create an injection of cash that will increase the “Current Assets” side of your working capital equation. This will also increase your current liabilities, given you will now have a new liability to pay each year over the course of several years. However, it will be a much smaller increase than your current asset increase and therefore has the potential to right-side your working capital.

Fix Your Negative Working Capital and Strategize for the Future with Brady CFO

You should avoid putting yourself in an underwater working capital position at all costs because you may not be able to dig yourself out. It’s best to have a flush amount of current assets to cover current liabilities, especially for a rainy day. However, if you’re struggling with negative working capital or simply want to ensure your business is positioned for success, Brady CFO offers monthly recurring fractional CFO services to help you achieve your goals. We start all partnerships with a risk-free Financial Clarity Assessment to evaluate your current cash flow and identify areas of opportunity and risk. With this assessment, you’ll gain a clear understanding of your business’s financial position and develop a roadmap to improve your working capital over time. We’ll also discuss a recurring monthly partnership that enables you to turn things around quickly and efficiently, helping you make informed decisions that drive growth and profitability. If you’re a small business owner generating $1-30 million annually in America’s backbone industries of food production and service, warehousing and distribution, manufacturing, construction, and professional service firms, contact us today to gain the financial clarity and strategic insights you need to thrive in today’s competitive landscape.

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