How to Calculate Net Working Capital Needs of Your Business?

Due to the current economic recession, small and medium scale businesses are facing a serious liquidity crisis. To make up for this lack of funds, public sector financial institutions disbursed around Rs.5.66 lakh crore to 41.81 lakh accounts between March and April of 2020. Beneficiaries of this financial package included the corporate, retail, MSME and agricultural sectors.

● Between March 20 and May 6, these lenders reached out to 95% of eligible candidates to extend an emergency line of credit.

Besides helping businesses stay afloat, such emergency financial packages can also boost the net working capital of a firm, allowing it to operate more efficiently.

What is net working capital?

The difference between the current assets and current liabilities of any company is defined as working capital or net working capital.

One can say that it reflects the present liquidity standing of a firm, using which the company can deal with its short-term financing obligations.

Additionally, it can also help sustain the day-to-day operations of the business.

Ideally, a company should hold higher current assets than its current liabilities. This would ensure positive working capital for the business.

The formula for working capital calculation

The simplest way to calculate net working capital is to subtract current liabilities from current assets.

However, with a detailed understanding of the life cycle of working capital, he/she can use the following formula to determine the working capital value.


Working Capital = Accounts Receivable + Inventory – Accounts Payable

How much working capital does your business require?

Understanding a business’s working capital needs can be difficult. To analyze the same, one would first need to study the operating cycle of the firm.

This cycle breaks up the accounts payable, inventory and accounts receivable into the number of days involved in each payment, collection or conversion.

For instance, accounts payable are analyzed according to the number of days it takes to clear a specific payment, while accounts receivable in this cycle is the number of days it takes to collect an account.

● As per Reserve Bank of India data dating back to February-end 2020, Rs.89.8 lakh crore worth of business loans were disbursed by financial institutions.

Additionally, the following factors also determine a firm’s net working capital requirements –

  1. Nature of business

    Net working capital needs differ based on the kind of business in operation. For instance, an online commerce platform does not need to devote capital for production or manufacture of goods.

    The only concern, in such a case, is selling the existing inventory to generate revenue.

    Therefore, the working capital requirement for such a firm would be much lower when compared to another company, which manufactures and markets its own products.

    Similarly, some businesses or industries are more competitive than others. Therefore, in highly competitive scenarios, a company would need to adopt new approaches.

    Doing so may necessitate increased capital expenditure. One of the mistakes to avoid when managing working capital is neglecting competitor comparison for your business.

  2. Business efficiency

    To determine a company’s net working capital needs, one would need to study and analyze its efficiency and production cycles.

    If it takes a long time to produce the goods or sell the finished products, such a company relies greatly on its working capital reserve for daily operations fulfilment.

    On the other hand, if a company can produce goods at a rapid rate and get the same moving soon, you do not need to possess considerable working capital.

    Individuals can calculate the working capital requirement for their businesses after considering all of the aspects mentioned above.

    However, during a working capital deficit, availing business credit from lending institutions is a wise idea.

    Such a decision can help a business stay afloat, even during financial crises. It is especially true for smaller enterprises, where capital is minimal, to begin with.

    ● Micro and small enterprises received Rs.10.95 lakh crore as loans by February-end 2020.

    Lenders like Bajaj Finserv offer a substantial quantum of business finance to eligible applicants, easing any working capital shortages.

    The lender also extends pre-approved offers to ensure a faster and more convenient loan approval.

    These offers are available on business loans, personal loans and several other financial products. Potential borrowers can check their pre-approved offer by submitting their phone number and name.

    Working capital is intricately linked with cash flow in businesses. Without proper cash flow at all times, a firm fails to realize its true potential.

    To prevent major setbacks, entrepreneurs need to calculate net working capital to stay in constant control, opting for loans when necessary.

courtneywilliams

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