Author: Greg Taylor

Working capital

Over the past few columns we have been looking at properly managing your cashflow. This week let’s look at working capital.

Share on Facebook

This is a measure of how comfortably you can fund day to day operations. It is the net position of current assets (the things you expect to sell or collect in next 12 months such as stock, debtors and cash) minus current liabilities (those things you will have to pay in the next 12 months such as creditors and outstanding tax). 

Your creditors are a source of working capital funds. Your debtors are a drain on working capital. You need to manage them closely and get the balance right. To do that you need to look at your balance sheet regularly. Your accounting software package or accountant can produce the figures regularly. 

Businesses can go broke for a lack of working capital. You may get a profitable order but if you don’t have access to funds to pay bills until you fulfil the order and get paid for it, what good is it to you? 

With a growing business, you need more working capital because you have to get in more stock and fund a larger debtors book. You can source working capital from retained profits, debt, leveraging creditors or injecting more capital into the business. 

A simple measure financial institutions use to look at how effectively a business manages its working capital is called the Current Ratio. It is current assets divided by current liabilities. 

The key is to look at trends over time with the ratio staying about the same or getting larger. As a general rule, 1.3 or greater is a reasonable figure. 

If working capital is tight talk to your financial institution or accountant early. There are ways they can help you to better manage working capital. 

Greg Taylor is Deputy CEO and Chief Financial Officer for the Hunter-based Greater Building Society. This blog also appeared in the Newcastle Post 15 August 2012.