There are two types of money required to run any business. Fixed money and working capital. With fixed money, where the structure of the business is properly woven, but the business is conducted properly with working capital.
If we call a certain amount of money invested in the business as the foundation, then it would not be wrong to call working capital as a wall. Working capital is the life-giver of any business. Businesses need working capital to run their business properly.
Many times it happens that some institutions/companies cut their non-essential expenses and keep aside that fund for the working capital. But, there are a large number of institutions/companies for which it becomes difficult to arrange working capital itself. In such a situation, working capital comes as a savior.
What is Working Capital?
If you understand working capital in one sentence, it is the difference between the current assets and current liabilities of a business. The working capital formula is as follows:
Working Capital Formula:
Working Capital (Current Capital) = Current Assets – Current Liabilities
Let’s understand it more simply: Suppose you have current assets of 10, 00,000 and current liabilities i.e. 8, 00,000, then in this case you have Rs 2, 00,000 working capital.
Working capital is a measure of the cash you have left after accounting for short-term liabilities. There are two types of working capital both positive and negative working capital.
What is positive and negative working capital?
Positive working capital
Positive working capital is said to be the situation in which the current assets exceed the current liabilities. In this situation the current liabilities or the arrears can be settled immediately i.e. the dues can be repaid. Inventories can be purchased and the business can be run continuously.
Negative Working Capital
In the case of a negative working capital, it becomes difficult to return short-term loans, buy inventory or conduct business by meeting the daily needs of the business. In this situation it becomes mandatory for you to take a working capital loan.
How much working capital is required for your business?
To understand this, one must use the working capital formula. It will turn out like this:
Working Capital Ratio = Current Assets / Current Liabilities
An example: 1,000,000 / 800,000
In the ideal form, the ratio of working capital i.e. working capital should be between 1.2 and 2. If the ratio is 2.0 or more, it means that you are facing difficulty in expanding your business.
Move towards taking working capital loan
Working capital is the amount by which the daily expenses of a business are met. Everyday business expenses are met through working capital management. When working capital management is not done properly, then in that case it will be a better option to take a working capital loan. Let us understand the conditions for which working capital loan is suitable:
- To maintain regular cash flow
In small scale industries or other small and medium businesses, customers borrow goods. The cash flow of the business is disturbed by lending goods on borrowings which is a result of getting late payments on the goods given on credit. But in business, money is needed every day, to meet this need, a working capital loan will prove to be better.
- To keep the fluctuations in seasonal sales right
In our country, there are some months of the year in which business becomes stagnant. The sale comes to a standstill. When a stocked product comes to a halt, the business money gets trapped due to the cost involved. In this situation, a working capital loan can be taken to run the business. Business owners can also opt for MSME loan.
- Helps in finding new business opportunities
If a business is going well, then it can also consider opening another business. Working capital loan will help better for this.
- To fill the cash crunch
Working capital loans can also be used to meet cash shortage in business
What is the working capital loan type?
- Trade loan – a loan provided by present or potential supplier is called a trade creditor working capital loan
- Bank overdraft facility – in this facility, the borrowers only pay for the interest applicable on the amount that has been overdrawn
- Short term loan – A loan that comes with fixed interest rate and the payment period which is maximum 12 months.
Loans for other business needs – the loan can be also taken during emergencies like renovating the office or shortage of funds to fulfil sales order or managing cash flows.