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Working capital is the money small businesses have at hand to cover day-to-day expenses. It's an important indicator of the business’s financial health. It acts as a cushion and offers opportunities for growth.
Working capital is an important financial metric to understand because it:
Gives you borrowing power: Lenders and other creditors will look at it as a measure of your company’s overall health and your business’s ability to take on new debt.
Can fluctuate: Even successful businesses struggle with maintaining enough working capital, especially businesses with seasonal fluctuations and companies with a large volume of outstanding accounts receivable. Analyzing your business’s financials regularly, including the balance sheet and profit and loss statement, can help you plan to meet potential shortfalls.
How to calculate working capital
Working capital is the difference between your liquid assets, such as cash or accounts receivable, and the money you owe in the short term, such as payroll, other monthly bills and debt payments.
Assets – liabilities = working capital
If you’re short on working capital, getting a small-business loan to fill a temporary shortfall is one solution. It’s not wise, however, to use working capital loans to cover long-term investments, such as real estate.