Mompreneur Special: Why Is Working Capital Important

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Did you know lack of capital is the second most common cause of small business failure? About 29 percent of small businesses fail because they run out of money!

As a business owner, you’re certainly taking every measure to give your enterprise the best chance of succeeding. This involves ensuring you have adequate working capital at all times.

If you’ve never come across this term, you’re probably asking, “Why is working capital important?” Well, it could be the one thing that keeps your business from grinding to a halt.

Continue reading to learn how working capital helps businesses.

But first off:

What Is Working Capital?

Working capital is the cash (or cash-equivalents) a company needs to meet its day to day trading costs.  In a layman’s language, it’s the money that remains in your business’ checking account, after deducting all your debts and liabilities.

In a technical language, working capital is the difference between your company’s current assets, such as cash at hand, accounts receivables, and inventory, and its current liabilities (accounts payables, salaries, taxes, and debt payments).

Now that you have a clear picture of what working capital is, let’s focus on why it’s important to maintain an adequate amount of working capital.

Take Care of Day to Day Expenses

Running a small business is more like running a household. Every day, there’ll be expenses.

For example, you might need to replenish office stationery, buy supplies for the office kitchen, fuel company cars, and whatnot. To take care of these expenses, you need working capital.

Sure, most day-to-day expenses aren’t pressing, but if you don’t have money at hand to meet them, there will be consequences.

For instance, let’s say one of your employees needs to go and meet an important client. They will need to fuel the company car and perhaps pay the client’s lunch or dinner. If your business doesn’t have adequate cash to meet the expense, your option will be to cancel the meeting, perhaps missing out on the client’s business.

In short, a lot of things can go wrong when your business is unable to pay for its day to day expenses.

Pay Fixed Costs

The thing with day to day expenses is they aren’t fixed. Your everyday expenses for this month won’t be the exact same as next month’s.

What doesn’t change, though, is fixed costs. Whatever season or financial situation your business is in, these costs won’t change. They include salaries, rent if you’re in a rented building, utilities such as energy and internet bills, and insurance payments.

You need working capital to pay your fixed costs every time they’re due. Without sufficient capital, you can imagine the harm a missed fixed cost payment can do to your business.

For instance, if you’re unable to pay rent, your landlord will have no option but to give you an eviction notice. If you’re unable to pay your employees on time, there motivation and productivity will take a hit. They can even sue you.

Handle Business Disruptions and Emergencies

Every business is prone to disruptions and emergencies. Some of these events can put you in a situation where you have to spend money in order to restore normalcy in your business.

For instance, imagine a scenario where burglars break into your warehouse and make away with your stock. Suddenly your business has no stock, yet orders are flying in. Your business operations are effectively disrupted.

In this case, you need to replenish your stock as soon as possible. If you don’t, your customers might cancel their orders and buy from your competitors.

This is where adequate working capital comes in handy. You’ll just spend the money you need to buy new stock and keep the business’ sales operations going.

The same applies when there’s an emergency. If a severe storm damages your business premises, for example, you don’t have to wait on your property insurance company to repair the building. This can take weeks or even months.

As long as you’ve filed the claim successfully and you’ve got adequate working capital, you can start making repairs as soon as the storm settles. This way, you’ll minimize the amount of revenue lost during a shutdown.

Gives You an Advantage When Borrowing Money

Are you thinking of going in for a business loan?

Whether you’re eyeing a term loan, equipment financing, or a business line of credit, your lender is going to look at several factors before making a lending decision. One of the things they will consider is the state of your current working capital.

You see, from an analysis of your business current assets and liabilities, one can tell a lot about its profitability and liquidity. If your business has a meager working capital (the difference between assets and liabilities is small), qualifying for a loan will be a lot harder. Your working capital account shows that you’re aren’t pulling in enough revenues to be able to service the loan you’re seeking.

How to Raise Working Capital

Now that you know the importance of working capital, how do you raise it?

If you’re yet to start your business, the best way to raise working capital is to include it in your startup capital requirements. When you start a business with enough money at hand, you’ll be able to take care of your expenses and costs, even if your business takes longer to become sustainably profitable.

If your business is already running, you can secure a working capital loan. This cash injection will help keep your business running.

Why Is Working Capital Important? Answered!

If you were asking, “why is working capital important?” you now know what it means to your business. Without it, your business will grind to an inevitable stop. What’s more, you also know the steps you can take to raise adequate working capital.

Stay tuned to our blog for more handy tips and insights.

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