A healthy working capital is very important for any business. Without sufficient working capital, sooner or later you as a business will not be able to meet your monthly financial obligations. But what is working capital? And what does working capital actually consist of? And how do you calculate working capital? In this blog, we explain it to you!
What is working capital?
Working capital is the money you set aside as a company to pay for day-to-day expenses. These financial obligations include paying suppliers, replenishing stocks and paying salaries. When you pay these costs, you do so from working capital. Not all costs that a company incurs fall under working capital. Are you making investments in the business, buying new machinery, cars or other business items? Such costs are not paid from working capital.
Calculating working capital: current assets and current liabilities
Now that we know what working capital is, it is time for the next step: calculating working capital. In a nutshell, working capital is the difference between current assets and current liabilities. Therefore, the formula for calculating working capital is:
Working capital = current assets – current liabilities
To explain the calculation of working capital, we will first briefly discuss current assets and current liabilities. Because current assets and current liabilities; what exactly does that mean?
What are current assets?
All the assets of a company, which are only present within the company for a certain period of time, are known as current assets. Among these current assets, you can think of, for example:
● the company stock (both raw materials and finished goods)
● debtors (invoices paid to you by the customer)
● liquid assets (bank accounts and cash)
What are current liabilities?
Whereas current assets are a company’s assets, current liabilities include a company’s current liabilities. These are financial liabilities that have to be paid within a year. Among these expenses, you can think of:
● taxes (e.g. VAT and corporate income tax)
● creditors
● interest on loans
● bank credit
How do you calculate working capital?
We are going to calculate working capital using an example. Before we do so, let’s take a closer look at the formula for the calculation again:
Working capital = current assets – current liabilities
When you calculate working capital, you start with current assets. Here, you look at what can be sold by the company in the near future. As mentioned, this includes stocks (€20,000 in this example) and debtors (€35,000). When you add the cash and cash equivalents (€50,000) to this, you have the gross working capital.
+ stock at €20,000
+ debtors at €35,000
+ liquid assets at €50,000
——————————————- +
= gross working capital á €105,000
To get from gross working capital to net working capital, we need to subtract current liabilities. As mentioned, for this you include taxes, creditors, interest and bank overdrafts. In this calculation example, the total current liabilities is €50,000. The total arithmetic for calculating net working capital, then comes out as follows:
+ inventory á €20,000
+ debtors at €35,000
+ cash at bank and in hand at €50,000
———————————————– +
gross working capital = €105,000
– current liabilities at €50,000
———————————————– –
net working capital = €55,000
Improve working capital with factoring
Do you have a working capital deficit as a company after calculation? If so, there are a number of ways you can improve your working capital. For example, as shown in the calculation example, debtors play an important role in working capital. Unfortunately, because of the legal payment period a customer has, you often find yourself waiting a long time for the money from a sent invoice. Generally, every invoice sent has a payment period of 30 to 90 days. So when a customer pays an invoice late, late or, in the worst case, not at all, this can have unpleasant consequences for your working capital. In such a case, factoring offers the solution for your situation. But what is factoring and how does factoring actually work?
Factoring is the solution when you are waiting a long time for the money for invoices sent. This alternative method of financing revolves around selling invoices. You sell the invoices to a factor – for example Factris – which then takes over the invoice from you. In exchange for the invoice, Factris advances the relevant amount within 24 hours. So with factoring, you are no longer dependent on the customer’s payment term, ensuring you have sufficient cash flow at all times to replenish your working capital. But factoring is more than just financing. When you use factoring from Factris, we also take care of the financial processing. So we ensure that the amount is eventually collected from the customer. It makes factoring not only a very effective, but also a very simple solution for improving working capital.