It’s easy to calculate working capital and doing so on a regular basis can make it easier to understand what’s happening with your company’s financial health. Think of it as a short-term snapshot of your company’s ability to make good on its obligations or to invest more in growth.

When and Why Should I Calculate Working Capital Forecasts?

You should be familiar with your working capital figures all the time. Young businesses may need to check their numbers on a monthly or even weekly basis, but more established ones will usually do it quarterly, when they’re seeing a shift, or when they are considering a new expense.

Step 1: Add Up Your Current Assets

To start, you’ll need to make a list of all assets you could liquidate in the next 12 months and the value of each. It doesn’t mean you will liquidate them, only that you could if you needed to. It’s also important to note that long-term assets, such as machinery and equipment, are not part of this calculation.

Examples of Current Assets

  • Cash on hand
  • Accounts receivable
  • Inventory
  • Short-term investments

Step 2: Add Up Your Current Liabilities

Once you add up the assets, you’ll add up your liabilities. Again, focus only on current liabilities — those you currently have or will have in the next 12 months.

Examples of Current Liabilities

  • Accounts payable
  • Accrued expenses (rent, utilities and similar)
  • Taxes
  • Customer deposits and prepayments
  • Other trade debts

Step 3: Calculate Your Net Working Capital

With these two numbers, you can calculate your net working capital, also referred to as NWC.

Use the Formula: Assets – Liabilities = Net Working Capital

If your net working capital is a positive number, it means you can meet your current obligations, but it’s important to remember that things like your accounts receivable and inventory may not turn into cash. For example, if customers owe you money, and it takes them longer to pay, you may not have that cash on hand when you need it. Because of this, it’s better to have a cushion in your net working capital.

Check Your Cushion by Calculating Your Working Capital Ratio: Working Capital Ratio = Current Assets / Current Liabilities

If you have a 1.0 or less, you’re basically breaking even and have no wiggle room. If you’re above a 2.0, you may not be leveraging enough of your cash for growth. The sweet spot is somewhere in between.

Explore Options if Your Numbers are Low

Seeing a change in net working capital isn’t necessarily a good or bad thing. It simply means that your company’s cash flow situation has changed. For example, if you crunched your numbers and your ratio was a 2.0, but you decided to invest in new equipment to grow your business, your ratio would drop. If it’s still higher than a 1.25 or so, you’re probably OK. That shift simply means you’re leveraging your cash flow wisely. However, if your net working capital starts out negative or your ratio is low, you’ll need to start making changes to ensure you’ll be able to meet all your obligations for the next 12 months.

Decrease Accounts Receivable

Money owed to your business by its customers is a good place to start. If you can decrease outstanding debts or get your customers to pay sooner, you’ll have more cash on hand to work with. Invoice factoring is one method to tackle this that doesn’t involve chasing your clients or changing up terms on them.

Reduce Inventory

When it comes to inventory, there are two main changes you can make. Ideally, you’ll find a way to take on more work to use up the inventory and earn more. Short of that, you can liquidate inventory, so you’ve got cash to operate with.

Negotiate Better Terms with Vendors and Suppliers

Work with your vendors or suppliers to extend the length of time you have to pay or negotiate better pricing.

Sell Long-Term Assets

Company vehicles, office equipment and similar items are not part of your short-term assets for the purpose of calculating working capital. However, if you choose to sell them, then the cash you earn will become a short-term asset, thus increasing your net working capital.

Refinance Short-Term Debts

Let’s say your business took out several short-term loans, including one to make payroll, another for new tires on a company vehicle and another for a new computer. Perhaps the business has a credit card, too. If all these will be due within the next 12 months, they all count toward current liabilities. However, you could request a long-term loan to refinance them all together. The principal, interest, and fees you’ll pay for the next 12 months will still be part of your current liabilities, but chances are, you’ll get three or five years to pay it off with a loan. You are, in essence, “robbing Peter to pay Paul,” and it may cost you more money in the long run to do this, but it can help your business keep its head above water in a pinch.

Get a Free Cash Flow Consultation

If calculating your net working capital has made you uneasy, or you feel uncertain about the future, get answers about the state of your business’s cash flow. Get a free cash flow consultation from Interstate Capital.