What Is Working Capital Management and Why Is It Important?
Businesses can’t thrive, or even survive in many modern cases, without a healthy model or framework for measuring and managing their financial health. In short, we’re talking about the crucial importance of working capital and effective working capital management. In this blog, we’re going to define these terms, outline their importance, and provide a few tips for implementing them into your business. Let’s get right into it, shall we?
What Is Working Capital?
Working capital is a fairly straightforward concept—it’s essentially the difference between a company’s revenue and spending. In more buttoned-up, financial terms it’s the difference between the organization's current assets (e.g., revenue) and liabilities (or expenses). Working capital provides a barometer of sorts for understanding a company’s full financial health and well-being. The better a company understands its working capital, the better-positioned it is to develop operational strategies to optimize the asset-liability ratio.
The 4 Main Types of Working Capital
There are four primary types of working capital that impact a business—net, gross, permanent, and variable.
Net Working Capital: What most people mean when they use the term “working capital,” this figure simply calculates the difference between a company’s assets and its current liabilities, or expenses.
Gross Working Capital: This figure quantifies the total combined value of an organization’s cash and other assets at a given point in time (e.g., cash, accounts receivable, inventory, or short-term investments). It does not subtract the liabilities.
Long-Term Working Capital: Also known as “fixed” or “permanent” working capital, this measures the minimum value of cash or other assets a company needs to have on hand in order to cover its current liabilities or expenses. There’s also reserve margin working capital, which determines the minimum value of cash or other assets a company should have on hand as a precaution or safety net in the case of unforeseen, costly events.
Short-Term Working Capital: This value applies explicitly to seasonal or other special, temporary needs related to working capital. As opposed to regular working capital, which is generally consistent from month to month, variable working capital considers seasonal or other temporary liabilities—like peak seasons (seasonal) or unexpected operational or business expenses that arise (special).
How to Calculate Working Capital
Once you know exactly what your assets and liabilities are, calculating working capital isn’t too difficult.
Current Assets - Current Liabilities = Working Capital
It often makes sense to quantify this value as a working capital ratio, as it better illustrates the proportional relationship between assets and liabilities:
Current Assets / Current Liabilities = Working Capital Ratio
What Is Working Capital Management?
The financial strategy of working capital management provides a framework for monitoring an organization’s working capital and how it’s being allocated. So, what is the importance of working capital management? To put it simply, working capital management combines the processes of inventory management and accounts management, creating a rounded and holistic view of the current assets and liabilities.
The process usually begins with increased visibility into the organization’s assets and liabilities, and then developing procedures or systems for monitoring these factors in real-time so they can make proactive decisions that keep their cash flow situation optimized. When working capital begins trending, positively or negatively, they can understand the reasons why and then determine the next best action for managing their capital.
What Are the Benefits of Working Capital Management?
It’s really difficult to meaningfully adjust working capital levels or ratios without a thorough understanding of the full financial picture—this is where working capital management comes into play. For many organizations, working capital management is essential to their ability to achieve business-specific objectives while maintaining a healthy balance between growth, profitability, and liquidity.
The number one goal of working capital management is to increase how efficiently and effectively a business’s money is being used in order to support the organization’s overall health.
Beyond that, working capital management empowers companies to:
Maintain their business cycle, even when encountering unexpected liabilities or unforeseen expenses
Ensure continued operational efficiency by always learning more about how their business processes impact—or could impact—their working capital
Optimize how and when they spend their working capital in order to increase overall profitability.
In Need of More Working Capital? It’s Time to Get Backd.
At Backd, we offer a flexible type of alternative financing to provide a short-term solution for companies’ working capital needs.
Here’s how financing through Backd is unique and different from other lending organizations:
We offer funding from $10k-$2M, with term lengths ranging from 4 to 14 months.
We don’t require collateral.
We accept automatic daily or weekly payments.
At the end of the day, our flexible solutions for working capital are designed to empower companies with the working capital they need with minimal hoops to jump through. We’re not like traditional banks or lenders, with stringent requirements that leave many small businesses scrambling for alternative financing (like Backd). Our loan alternatives provide peace of mind by being both faster and easier than working with traditional banks.
