In this sequel, we address the numbers question. How much Working Capital Loan does my business need?
An ideal working capital management can be defined as striking a balance between two key factors: profitability and liquidity. Profitability is determined by the use of cash to invest in long-term assets. For example, Research and Development. These assets maximizes returns in the long run. Liquidity refers to a sufficient level of cash on hand. This sum aims to cover operational expenses, repay debts and still have an adequate amount left. A business should have a financial reserve at all times to minimize the risk of insolvency.
A useful tool for determining the health of your business’s Working Capital is the Working Capital Ratio.
Working Capital Ratio = Current Assets / Current Liabilities
A general rule of thumb for Working Capital Ratio, a healthy ratio lies between 1.2 and 2.0.
If your Working Capital Ratio is lower than 1.2, your business may have difficulty with operational cash flow. This includes footing your bills and repaying debts on time. Your business is also susceptible to insolvency issues in times of financial emergencies.
If your ratio is higher than 2.0, it can be an indication that your business is not maximizing its profitability potential. The cash can be put into better use in investment and new growth opportunities. The aim is to generate profit in the long run.
The Working Capital Ratio equation helps businesses find the pivotal point between profitability and liquidity. A business needs to have ample cash for business operations and repayment of debts. However, not to the point of having excessive cash lying stagnant. This helps you figure out how much Working Capital Loan your business needs.