Sudden requirement of financial capital can happen in anytime in today’s highly dynamic business ecosystem. Even the most successful businesses fall short of capital and funding at times. For instance, a business can enjoy high production and sales, but suddenly encounter supply issues and delayed payments by vendors. Such situations can leave you in a financial crunch.
This calls for a proper understanding of what is working capital management, the working capital ratio, and the importance of available financial assistance. These days, banks, and Non-Banking Financial Companies (NBFCs) are offering financial assistance in the form of Business Loans and MSME loans.
These loans are offered to business owners and entrepreneurs to help them recover from financial crises quickly and keep their day-to-day operations running. Understanding why working capital is important is essential for your enterprise’s long-term and short-term goals. In this blog, we will discuss what is working capital management, and how you can avail of Business Loans to keep your operations up and running.
What is Working Capital?
Working capital, in financial terms, is a company’s short-term financial liquidity for managing the day-to-day operations. Working capital considers the amount of cash you currently have and all the assets that can be converted into cash within 12 months. Then, it is compared with your current short-term liabilities.
A business’s current assets and current liabilities are mentioned in its balance sheet. Assets and liabilities are considered current if you expect the assets to be used and the liabilities to be paid within a period of 12 months.
The formula for the working capital ratio is:
Net Working Capital = Current Assets – Current Liabilities
What is a Working Capital Ratio?
Working Capital Ratio = Current Assets / Current Liabilities
Your working capital ratio depends on the size of your enterprise, your industry/domain, and the stage your business is at currently. For instance, a company that has quick product turnover and effective inventory management in place might have a lower working capital ratio. This is because the company does not keep enough inventory in hand, which is a large portion of current assets.
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Generally, a working capital ratio of one (1) indicates that you have enough capital to cover your short-term expenses, but you don’t have any left in reserve. You must monitor your working capital from time to time so that you don’t end up having more liabilities than your current assets.
A working capital ratio higher than one (1.5 or above) indicates that the business is financially healthy. It means that you have enough cash to cover your liabilities and have some extra funds. Having a good working capital ratio also means that you can use funds to buy long-term assets and invest in growth opportunities in the future.
A working capital ratio lower than one (0.5) can potentially be a sign of worry. It means that your business is incapable of covering its short-term expenses, and its assets aren’t enough to pay for day-to-day operations. A lack of working capital can harm your company’s growth and might lead you into a debt trap.
The working capital ratio must be optimum – neither too high nor too low. If the working capital ratio is too high, it means that there could be too much unsold inventory, unutilized cash or a bloated “accounts receivable”. Conversely, if the working capital is too thin, it could indicate that your existing liquid assets are insufficient to take care of day-to-day liabilities. Hence, a balance is required.
Importance of Business Loans for Working Capital
Lack of working capital when you are trying to expand a new business opportunity can hamper your business goals. Besides this, your day-to-day operations will get impacted due to a lack of funds. Hence, understanding what is working capital management and its importance in small businesses is imperative. In such cases, borrowing a Business Loan for MSMEs can be a good idea.
Business Loans are unsecured loans and are available at competitive interest rates. You can use these funds for business activities without any end-use restrictions. Business Loans can be used to infuse working capital as well, making them a multi-faceted financial tool.
Most of the banks and NBFCs have gone digital, enabling young entrepreneurs and small business owners to achieve their dreams through quick funding options. You can apply for a Business Loan or MSME loan online and get funds disbursed into your account in a matter of hours.
Further, for better loan repayment planning, you can use an online Business Loan calculator for determining your equated monthly payments (EMIs). The Business Loan calculator is available online, is easy to use and is free. Enter your loan amount, loan tenure, and the interest rate offered to you, and the tool will give out the amount that needs to be paid monthly.