How to Determine Your Business’s Working Capital Needs

Small businesses use working capital to pay their bills, make purchases, and afford other operating costs. Although it is easy to understand what working capital is, it’s tricky to determine how much working capital your business needs. Working capital depends on several factors including:

  • The industry of your business
  • Operating cycle
  • Overall efficiency
  • Cash flow
  • Inventory management
  • Business goals

In this post, you’ll understand how each of these factors affect your working capital performance and how you can determine the working capital that your business needs to grow.

How Much Business Working Capital Do You Require?

Type of Business: Seasonality and Operating Cycle

The type of business you run, and your operating cycle go hand-in-hand. The difference is that the time required for a business to receive cash from customers may vary quite a bit even between businesses in the same industry.

Seasonality of Sales

Your business’s industry is also important because working capital needs may vary depending on seasonality. In some cases, you may need more cash on hand during busy seasons to meet all of your needs. Or, if sales slowdown, you may require additional working capital to stay afloat.

It’s important to note that if your business has seasonal needs, you might benefit from contacting a financial institution to see if you can get approved for a working capital loan. This will enable you to afford your seasonal expenses, without having to risk acquiring significant debt, or not being able to pay for costs entirely.

Operating Cycle

Your business day-to-day operations will affect how much working capital you need. For example, a wholesaler would need a larger amount of working capital during that time than a fast-food business owner. The wholesaler simply can’t generate cash quickly enough to afford all his business expenses, so he’ll need a larger safety net.

Business Goals

Your short term and long-term goals play a huge part in determining the working capital needs of your business. One business owner may be fine with having $100,000 unused cash while another might consider that amount to be too much. It depends on how much you want to invest in growing your business. It comes down to whatever is your personal preference.

If you decide that your business requires additional working capital, you should consider applying for a small business loan, business line of credit, or a credit card. This is especially helpful if you decide that you have aggressive goals that will require you to make significant investments in areas of your business.

Operational Efficiency, Costs, and Payment Cycles

Small nuances in the way you do business make your needs unique. For example, you may have special taxes to pay or regulations to follow. The timeliness of when you receive payment for goods and services can affect your working capital needs.

The Bottom Line

Evaluating and managing working capital needs will give you a great insight into if your business is operating efficiently. You’ll gain clarity on where you need to cut back and where you can afford to spend surplus capital to grow your business.