What is Your Company’s Net Working Capital Requirement? | Behalf
Your Net Working Capital Requirement
Your company needs working capital to run. Working capital is the cash that circulates throughout your business, covering everything from operational expenses to production costs. Nevertheless, net working capital is the actual amount of money your business has at its disposal to use on the day-to-day. In reality, your business working capital might look very different from its net working capital. Net working capital is a simple calculation of current assets minus current liabilities. In other words, it is the measure of your business liquidity at any given point in time.
Every business requires a different amount of net working capital to stay afloat. Use the following formula to calculate your business’ net working capital requirement:
(Net Working Capital Requirement) = (Inventory + Accounts receivable – Accounts payable)
If you think this calculation is deceivingly simple, that’s because there might be other factors influencing your business’ need for net working capital. This calculation is just the beginning of your cash flow analysis. Not only is the way you manage your business affecting the amount of net working capital your business needs to function, there are also factors beyond its control. This article explains what other conditions factor into your company’s net working capital requirement.
Nature of the Business
Your business model and industry play a major role in how much net working capital your business needs. Depending on the product or service your business provides, you may not have an inventory or a traditional production cycle. For example, a company that provides a service online does not have to buy raw materials and turn them into a finished product. By eliminating those production costs, they require less net working capital than a traditional manufacturing company.
At the same time, some industries are more competitive than others which requires businesses to adapt their practices to match those of their competitors. If your competitors offer credit to their customers, your company might have to follow suit. Credit, otherwise known as Trade Terms, can put an unnecessary strain on your working capital cycle. As you wait around for customers to honor your payment terms, you tie up funds that would otherwise be net working capital.
It’s important to note that the amount of net working capital required to run your business fluctuates over time, especially when your business is seasonal. Typically a business that is off season requires more of a net working capital reserve to cover its operational costs, when less money is coming into the business. Nevertheless, peak season can also burn up a business net working capital reserve when demand is at an all time high. This is a good problem to have, as far as problems go. But running low on liquidity is a problem, regardless of the cause.
The way your business manages its time and resources shapes its need for net working capital. How long is your production cycle? If it takes a long time to create your product and an even longer time to sell it, your working capital cycle moves slower which makes your business more dependent on its net working capital reserve. Consequently, a business with slow turnover requires a larger amount of net working capital to cover its day-to-day business expenses. High production costs amplify a business’ dependency on their net working capital, especially with a small average order value (AOV).
Businesses that are dependent on net working capital must plan appropriately or they risk running out of cash. Cushion your business net working capital to ensure you always have enough cash to capitalize on growth opportunities. Behalf can increase your business buying power up to $50,000, giving you more control over your cash flow. You can use Behalf to pay any of your suppliers that accept cash, check or MasterCard. Adding Behalf to your payment arsenal gives you extra time to pay. Behalf pays your supplier instantly and you get up to six months of extra time to fulfill payment. Customize a flexible weekly or monthly payment schedule on each individual purchase. Behalf works just like net working capital, allowing you to cover recurring business expenses and make opportune investments in growth and expansion without weighing down your credit cards and business accounts.