Having enough cash to function from day to day is particularly important during the startup phase of your business. Keep an eye on your capital, in case you have to raise more equity or take out a loan to have enough.
Calculating Your Working Capital
To calculate your working capital, subtract your current liabilities from your current assets.
If your current assets are $7,500 and your current liabilities are $5,000, then your capital is $2,500.
If your current assets don’t exceed your current liabilities, you may run into trouble paying back your creditors. The worst-case scenario, in that situation, would be bankruptcy.
Working Capital Ratio
You can also calculate your working capital ratio, which measures whether your company has enough short-term assets to cover your short-term debts.
If your current assets are $7,500 and your current liabilities are $5,000, then your ratio is 1.5.
A working capital ratio below 1.0 indicates a negative working capital. If you track your ratio over time and notice that it’s decreasing, it could be red flag – you’ll have to investigate to determine the cause.
A high working capital ratio may not be a good thing. A ratio greater than 2.0 may indicate that you’re not investing your excess assets. A high ratio may also indicate that you have too much inventory or accounts receivable, neither of which can be used to pay back your short-term debts immediately.