What is a balanced working capital position?
Purchasing stocks, paying wages and paying suppliers – you need working capital to keep your business running smoothly. But how much working capital does your business need to keep running smoothly or even to expand?
What is working capital?
You use your working capital to meet your short-term payment obligations, for example, to pay your suppliers and employees, and to repay other current liabilities (with a term of a year or less).
How much working capital do you need?
In theory, you need sufficient working capital to cover your day-to-day operating costs. In practice, it’s useful to have a financial buffer to fall back on. This allows you to more effectively anticipate working capital changes and varying working capital needs.
With an extra working capital cash reserve, you can:
- Seamlessly bridge the period between expenditure and income
- Easily absorb expected or unexpected costs
- Compensate highs and lows in your turnover
Calculate your net working capital
To check whether your business is able to meet all its short-term financial obligations, you can calculate your net working capital. Net working capital is the difference between your current assets (inventories, trade receivables and liquid assets) and current liabilities (suppliers and short-term debts):
1. Example calculation of positive working capital
| Assets | Liabilities | ||
Fixed assets |
2 500 | Equity |
1 000 |
Inventories + orders on hand |
100 | Long-term debts (> 1 year) |
1 100 |
Trade receivables (outstanding customer invoices) |
350 | Facilities (buildings + energy) |
500 |
Liquid assets (bank account balance) |
500 | Suppliers |
100 |
Short-term debts (< 1 year) |
400 | ||
| Total assets | 3 450 | Total liabilities | 3 100 |
Net working capital = 3 450 - 3 100 = 350
In this example, sufficient liquid assets are available to meet short-term financial obligations. The business owner has a low working capital need.
2. Example calculation of negative working capital
| Assets | Liabilities | ||
Fixed assets |
1 500 | Equity |
3 000 |
Inventories + orders on hand |
100 | Long-term debts (> 1 year) |
2 000 |
Trade receivables (outstanding customer invoices) |
250 | Facilities (buildings + energy) |
1 500 |
Liquid assets (bank account balance) |
200 | Suppliers |
700 |
Short-term debts (< 1 year) |
800 | ||
| Total assets | 2 050 | Total liabilities | 8 100 |
Net working capital = 2 050 - 8 100 = -6 050
This business owner has a high working capital need and may not be able to meet their payment obligations in the short term. They must cover a cash shortage of 6 050 euros.
How can you finance your working capital?
With working capital financing, also known as business credit, you can bring more balance to your working capital and cash flow.
Depending on your working capital needs, there are several ways to draw down your business credit:
- You can flexibly overdraw your business account
- You can draw down one or more straight loans for a specific period
- Or you can combine both drawdown methods
Benefits of working capital financing
Working capital financing also allows you to respond quickly to:
- Suppliers: pay in cash and receive additional supplier discounts
- Customers: give customers more time to pay
- Business opportunities: balanced working capital gives you more financial flexibility to expand your business