The Importance of Working Capital in Small Businesses

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The Importance of Working Capital in Small Businesses

Working capital is a term small business owners need to be familiar with, as it is the cornerstone of their daily operations. A good understanding of working capital is essential for small business owners at every stage and can enable you to take your business to the next level.

What Is Working Capital?

Put simply, working capital represents the assets you have available to turn into cash in order to pay short-term debts associated with running your business like purchasing inventory, equipment, and paying salaries. Cash and accounts receivable are two examples of assets that count towards a company’s working capital. For every business cycle (the time it takes to prepare your product or service, sell it, and then collect on it) the amount of working capital you have at your disposal is your current assets minus all current liabilities.

Why Is It Important?

The importance of working capital cannot be stressed enough as it is a strong indicator of a business’s ability to manage upcoming expenses. Having little working capital makes it very difficult to effectively run a business because the payment of day to day expenses depends on having these liquid assets available when needed.

How to Improve Your Working Capital

Get a Cash Flow Forecast

Understanding your financial situation is key to figuring out how much working capital you have, and how much you need. Taking the time to get an accurate forecast of when you will run out of cash will help you determine whether – or by how much – you need to improve your working capital.

Manage Your Accounts Receivable

Converting your accounts receivables into working capital may require a reform of your methods of collecting customer payments. Implementing changes such as automated reminders and simple payment methods will promote prompt payment within your client base and will improve your working capital.

Manage Your Cash

Although it may seem like a good idea to pay your bills quickly and as they come, if you find yourself with minimal working capital it is worth reconsidering how and when you pay your bills. Prompt payment is important for avoiding late fees, but if you know you need cash to pay for an immediate expense, hold off on paying the bills until your customers pay you. This way you won’t be strapped for cash at a critical time.

Get a Cash Injection

Many small business owners who don’t have enough working capital and cannot get enough money from your bank use online business loans to access working capital. Online lenders such as Lendified, a leading Canadian lender founded by former bank executives, offer short-term business loans accessible through a simple online application. Lendified offers a free quote so it is easy to see what your options are before committing to anything.

Manage Your Inventory

In a similar vein, while buying inventory in bulk has its advantages, it is still important to consider whether you can afford to sacrifice valuable working capital for products that could take a long time to sell. Be sure to do the math to ensure you have adequate working capital for the remainder of the business cycle before making big purchases.

We would like to thank Austin Pantaleo from Lendified for his expert insights provided in this post. If you have any questions or comments, please share them below.

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Omar Visram
About Omar Visram
Omar Visram is the Co-founder and CEO of Enkel Backoffice Solutions Inc. Headquartered in Vancouver, Enkel provides bookkeeping, payroll, accounts payable and accounts receivable services to over 300 organizations Canada-wide.