Working Capital: What is it and Why Does Your Small Business Need it?

Working capital; it’s a term we throw around a lot here at Lumi, but what exactly is it and why is it important for your small business? Today, we’re going to share everything you need to know about working capital, including how you can find out your working capital ratio.

What is Working Capital?

In a recent blog post, we explained working capital as “the wealth of a business which is used in its day-to-day trading operations”. It’s extremely important for paying off short-term expenses or debts and keeping the business running smoothly. A company can either have positive or negative working capital (which we’ll explain more below).

Find out 29 more business loan terms here.

How to Calculate Your Working Capital Ratio

You can easily work out your working capital ratio using the following formula:

Working capital ratio: current assets divided by current liabilities

This ratio indicates whether a company has enough short-term assets to cover its short-term debt. A good working capital ratio is considered to be anything between 1.2 and 2.0.

A ratio below 1.0 indicates negative working capital (not enough assets compared to liabilities), whereas a ratio above 2.0 indicates positive working capital. Whilst positive working capital is better than having negative working capital, it can indicate a business is not using its excess assets effectively to generate maximum possible revenue.

Tips to Manage Your Working Capital

There are many ways that you can manage your working capital effectively to ensure it remains neutral or positive, as opposed to negative.

Here’s our top 10 tips for managing working capital

1. Keep on top of your invoices
If you’re not sending your invoices in a timely manner, then it’s likely that you’re also not being paid in a timely manner. Negative working capital can result from too many unpaid invoices, so ensure you don’t fall behind.

2. Manage late payments effectively

Speaking of unpaid invoices, you’ll also want to have an effective system in place for managing late payments if you want your working capital ratio to remain in the neutral or positive zone. Ensure you have terms and conditions in place for late payments, including a small fee for those who fail to pay their invoice within a certain time period.

3. Set cash flow targets
Just as it’s important for business owners to write down their goals, it’s also vital you plan and set cash flow targets that must be met. What working capital is required to help your business grow successfully? What steps can you take to achieve your working capital goals?

4. Make it easy for customers to pay you
One way you can avoid late payments (and therefore, boost your working capital) is to make sure your payment methods are very accessible. Think about online payments, bank transfers and credit cards. There isn’t a ‘one size fits all’ approach to receiving payments, so variety really is the key here.

5. Effectively manage your inventory
Inventory management is another important component of managing your workflow, as you need to get the balance just right. Too much inventory means you’re spending more money on stock than what is necessary. Too little inventory, however, means you’ll be running out of stock and not meeting your customers’ demand (therefore, missing out on additional sales).

6. Pay your own debts on time
You might think paying your own debts goes against positive workflow, but it’s a vital component of managing your working capital. You see, late payments can result in additional fees or charges, all of which can bite into the money you need to manage your day-to-day expenses. You also don’t want to jeopardise your credit rating, something that could negatively affect your chances of getting a business loan.

7. Control expenses
To keep your working capital at a healthy level, you’ll also want to make sure you’re not spending unnecessarily. Determine what expenses are important and which ones you can probably go without. Remember, to obtain a working capital ratio of 1.2 – 2.0, your current assets need to be larger than your current liabilities.

8. Delegate or outsource
Are there some less-important tasks you find yourself spending time on, when you could be doing more vital work? Rather than focusing on tasks outside of your specialty, it’s better to outsource these to a professional. As a business owner, your primary concern should be maintaining healthy working capital, along with all of the tasks that come with it.

9. Utilise helpful software
Did you know there’s plenty of software designed for small business owners to help them manage their cash flow more effectively? Just some of the most popular include MYOB, Xero, and Quickbooks.

10. Make informed financial decisions
It can be easy to jump into a financial decision quickly if you believe it’s a once-in-a-lifetime opportunity, but we would advise caution. Before making a big decision that will greatly affect your working capital, first weigh up the pros and cons and speak to an adviser or mentor you trust.

How Can a Working Capital Loan Help You?

A working capital loan is beneficial for helping small businesses cover everyday expenses. Its focus is on the short-term commitments of a business, rather than long-term strategies such as investments or expansion.

Here’s 10 ways a loan designed for boosting working capital can help you:

Pay staff wages
Cover operational costs during busy periods (when payments are delayed)
Boost stock or inventory
Provide a safety net during seasonal fluctuations
Purchase equipment or machinery
Work space renovations
Hire new staff
Advertising and marketing
Pay BAS or tax payments
Purchase new furniture or fixtures

Other Benefits of a Working Capital Loan

As you can see, a working capital loan can dramatically help your business in covering day-to-day expenses, but it also offers other benefits, including:

Flexibility
Working capital loans are flexible, as they’re designed to meet your business’ individual needs. They usually work as a short term loan, meaning you can borrow $5,000 up to $100,000 on terms of 3 – 12 months. If unsecured, you won’t even have to put up a valuable asset as collateral.

Speed
A working capital loan through an alternative lender, such as Lumi, can be approved in as little as 24 hours, with your desired funds deposited into your business bank account the next business day. This gives you access to the working capital you need, as soon as you need it.

Ease of application
We offer working capital loans which can be applied for online in less than 10 minutes. Forget lengthy application processes, interviews, appointments, or waiting weeks for approval. It’s never been easier to apply for a working capital loan.

The Different Types of Working Capital Loans

There are a number of different business loans which are designed to help you increase your working capital. We’ve listed each of these below. Simply click-through for more information.

Do You Qualify for a Working Capital Loan?

Each lender’s requirements are different, so it’s best to check these before you take the time to apply for a working capital loan. At Lumi, for example, we only ask that an applicant has the following:

An ABN or ACN
At least 6 months in operation
A minimum annual turnover of $50,000

How to Apply for a Working Capital Loan

If you’re ready to take the plunge and apply for a working capital loan, the process is easy. Just visit our website or call 1300 00 LUMI with the following documentation on-hand:

Driver licence
ABN/ACN
Credentials for your online business bank account

Once you apply, you’ll receive a lending decision within 24 hours. If approved, your funds will be deposited into your nominated business account as early as the next business day.

Want a fully transparent business loan that contains no hidden charges or fees?
Get started with a Lumi business loan today.

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