How to Calculate Working Capital
When it comes to the daily operations of your business, it is a good idea to know how to calculate your circulating or working capital. This can help you see what you can use to expand your business, boost morale or more. To calculate how much circulating capital you have, you will want to subtract your current liabilities from your current assets. So, it is a good idea to know what each of these terms means.
Circulating capital is the amount of liquidity your business has in the short term. This is what you have on hand to cover emergencies or expansions without getting into trouble when your utility bill comes due. For instance, if you have a grand on hand right now and your current liabilities are five hundred dollars, then your working or circulating capital is five hundred dollars. You can use this towards future expansion, stocking up on supplies for big orders or even a pizza night for your employees, all without putting your bills in trouble.
The current assets portion of your working capital equation refers to your cash, inventory and accounts receivables. It can also include any marketable securities and anything else that can easily be converted into cash within a year. This does not mean that you have to convert everything to cash immediately to get circulating capital, just that it could be done if you needed to.
Just like current assets are what you can turn into cash in the next year, liabilities are payments that you will have to make in the next year. This includes accounts payable, rent, taxes, and other expenses. It is not necessarily a bad thing to have a negative circulating capital amount, especially if it means that your products are selling just as fast as you can stock them. It is a good idea, however, to reduce your liabilities as much as possible to try and turn around negative cash flow and save for future growth.
Working capital is the amount you could have in cash within a year after you have converted all your assets and paid off all your liabilities. You can do this math without converting anything to cash, however, and it is a good benchmark of how well your business is performing. Positive cash flow means that you can save and grow in the future while a negative one can pinpoint areas for improvement moving forward.