What is the Purpose of Working Capital?

One-third of businesses will survive 10 years of business.

A reason that so many businesses fail in the first 10 years is often because of a lack of planning. It could be they haven’t mastered out the financial part of what it means to own a business. 

But the point is, it’s difficult to own a business and make it last more than 10 years. 

This is why it’s important to take a look at the purpose of working capital. If you’re unfamiliar with this term, working capital refers to the difference between businesses’ current assets and its liabilities. 

It’s critical to know everything about working capital in your business and how to use it in a strategic way. 

What Mistakes Does Small Business Make with Working Capital? 

Liabilities can be the cost of rent and goods to produce the product. Assets can be checking and savings accounts. If a business has more liabilities than assets, then it’s working capital is negative. 

Ultimately, working capital is the short-term financial health of the company.

Lack of planning is one of the most common mistakes that small businesses in working capital. 

They don’t take into account their assets and their liabilities. They don’t have a business plan in place when they try to take out a loan that gives them working capital. 

A strategic business plan will detail your products and your services. The plan will also talk about revenue, cash-flow to date, and projected financials. Having this prepared when you apply for a loan can help you secure a loan that gives you upfront working capital that you need to operate a successful business. 

You should also be aware of your credit score and the kind funding you need if it’s a business line of credit or invoice factoring. 

The mistake of not being prepared, not having a business plan, can delay your business. 

When you see a lender, you need to be prepared to show tax records from the previous 3 years, your business plan, financial statements from the past year, legal documentation, and possibly more if your lender requires it. 

You can find more information on business capital, specifically 7 ways business working capital can help propel your business.

Why Do You Need Working Capital? 

Every business needs working capital to keep up with business, especially when it comes to scaling a business. 

While negative working capital means you have more liabilities than assets, it also means you can’t pay for your commitments. In other words, you are spending more than you make. 

If you have positive working capital, you have additional resources to pay for scaling your business. 

You can pay for additional positions to be opened. You can also invest in marketing resources that can pay massive dividends to your business. 

When you pay for marketing, you are investing in your business. You are trying to get the word out on social media or other forms of marketing. 

The purpose of working capital is to use the funds to keep your business profitable. It does this by investing in resources that help your business grow. That may mean hiring a media manager or marketing expert. 

You may also decide to promote your business on Google AdWords or another form of marketing.

The point is, every business needs positive working capital if they want to keep their business from crashing. More importantly, if that business wants to invest in itself than it’s important to look at marketing or other forms of resources that can help you achieve that goal. 

How Can You Improve Working Capital? 

Maybe your business has working capital, but it’s not paying off for you. It could be that you are allocating resources in the wrong spot. 

You can improve your working capital by focusing on sales. Are you making enough sales to generate enough profit? This is where your initial focus should be on your business. 

Look at sales and then look backward. You need to assess the customer journey. The better the customer journey, the more likely that customers will buy from you.  

Once again, this is why marketing is important. Your business isn’t just about a customer who needs your product and they buy. Small businesses are always competing against each other, which is why a focus on the customer journey is critical to getting more sales. 

Also, when you borrow money that you are using as working capital, you should consider borrowing for the short-term rather than the long-term. It can assess how profitable you are in the short-term before you borrowing long-term. 

You can set short-term goals that follow your business plan. This can be a marketing campaign or a business strategy to promote more sales. The point is, a short-term loan gives you an idea of where your working capital goes. 

The ultimate goal is to increase your assets and not your liabilities. If you have more assets than liabilities, you have positive working capital. 

The Purpose of Working Capital is to Help Your Business Strategically Grow

It’s easy to ignore financial advice on working capital. 

You might have thought that the only thing you need is a remarkable product to keep your business afloat. If you do that, you will be falling into the same mistakes as other businesses. 

To avoid business catastrophe, you have to calculate your assets and your liabilities. The answer will give you an idea of how much you can spend on your business. Remember, the purpose of working capital gives you an idea of how much you can spend to continue or scale your business.  

The ultimate goal to create a profitable business. Of course, that takes extensive business and financial planning. More importantly, it starts with taking action and knowing what your working capital is. 

For more information on jump-starting your small business and other financial resources, visit our website or contact us.