Working capital (WC) is the total amount invested in a business to meet its daily operational requirements. It comprises a company’s current assets and liabilities and stands as an accurate measure of its liquidity.
The optimum utilisation of WC or net working capital strengthens a business’s financial position and can be measured through the working capital ratio. It is the ratio of current assets to current liabilities. A ratio of 1.5 to 2 is considered ideal for the business and should be maintained, considering other factors like the business’s type, its size, operating cycle, and such other factors.
A WC ratio below 1 reflects a working capital deficit and indicates that the firm needs to introduce additional finances like a business loan to maintain the same. In such cases, you must also take other correctional measures to maintain this ratio in the future. Also, if the ratio exceeds 2, it shows excessive WC, which should be brought down to the ideal requirement.
Working capital can be of different types and is calculated through various formulas. However, the most common working capital formula utilised by companies is given below.
Working capital = Current Assets (CA) – Current Liabilities (CL)
Along with the estimation of how much working capital your business needs and this calculation, you can implement a proper plan for working capital management.
Additional Read: Benefits of Business Loan for Your Small Business