Using working capital to grow and transform your business

Take outs:

• Working capital is determined by subtracting current liabilities from current assets. It's crucial for businesses to have enough working capital to cover day-to-day expenses.  
  
  
• Even businesses with substantial working capital can experience cash flow issues due to the operating cycle, where cash is tied up in inventory or accounts receivable. Access to well-planned working capital finance can bridge the gap between money out and money in.
  
  
• Various finance options, such as traditional bank overdrafts, loans, debtor financing, lines of credit, and unsecured loans, can help businesses unlock working capital. These solutions provide flexibility to manage cash flow and take advantage of opportunities.

Using working capital to grow and transform your business

Working capital is the money your business has in its pocket, and it plays a crucial role in day-to-day operations and long-term growth. This article explores how to calculate working capital, determine how much is enough, and why even financially healthy businesses may still need external finance. We’ll also look at various finance options available to unlock working capital, with practical examples of how businesses can manage their cash flow cycles to seize opportunities and mitigate risks.

Calculating how much you have

On paper, it's a basic formula: your current assets (accounts receivable, inventory, cash) less your current liabilities (accounts payable) is your working capital. 

How much is enough?

At a bare minimum, businesses need to cover wages and expenses. A working capital ratio (current assets ÷ current liabilities) between 1.5 and 2 is considered ideal, and acceptable is 1 and 2 times¹. Anything lower indicates a business may have difficulty in meeting its day-to-day financial commitments. Anything higher could indicate assets are not being fully utilised. A generalised analysis which varies between industries and needs to be considered on a case-by-case basis.

Why do healthy businesses still need finance?

Businesses with substantial working capital can still get caught short because cash is tied up in the operating cycle – that is, the time it takes to convert investments in inventory and resources into cash from sales. A long operating cycle can impact liquidity, leaving businesses asset-rich but cash poor. Just-in-time inventory management may minimise lag but unforeseen circumstances like insolvencies, disrupted supply chains or delays can impact an otherwise solid business.

Well-planned working capital finance solutions are essential for SMEs to bridge the gap between money out and money in and maintain the flexibility to pounce on opportunities or ride out bad debts.

What type of finance?

Options to unlock working capital include (but are not limited to):

Example of how you could finance your working capital cycle

Prepare to pounce

Unlike more targeted business loans, working capital finance can be used for a variety of purposes. Get on the front foot to seize opportunities in a recovering market. 

¹ The Working Capital Ratio and a Company's Management (investopedia.com)

The information in this article was sourced from AFG. Any advice/information contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person or company. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. The article has been written for general informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. We encourage you to consult your own tax, legal and accounting advisers before engaging in any transaction. Information in this article is correct as of the date of publication and is subject to change.

Credit services are provided by Kelly Partners Finance Pty Ltd as an authorised credit representative under Australian Credit Licence 389087.