Working Capital


Here we are, the economy has turned around, your company is back in the black, and you have the opportunity to expand. So you go to the bank for a loan only to be denied due to insufficient Working Capital.

How can that be? I have plenty of Working Capital; you say to yourself.

We all use the term Working Capital, but we may not understand the exact meaning. Many think of working capital as being synonymous with Cash, but that’s only part of the answer.

“Working Capital” is made up of the short term assets the business has available and includes Cash (money in the bank), Inventory and Accounts Receivable.

For example, if you have:

  • $50,000 Cash
  • $200,000 in Inventory
  • $375,000 in Accounts Receivable, which amounts to
  • $625,000 in Current Assets or Working Capital

Sound like a lot of money? It is until you plug in the other part of the story—the encumbrances. That is the amount of money what you owe to other people who have already laid claim on part of your working capital. These are the short-term amounts due. The Accounts Payable, Payroll and Tax Liabilities and any Short-Term Notes, are subtracted from working capital to yield Net Working Capital, which at the end of the day is the real reason your loan was denied.

If you owe:

  • $300,000 in Accounts Payable
  • $75,000 in Payroll and Tax Liabilities
  • $200,000 in Short-Term Notes (which includes this year’s principal payment on loans i.e. building mortgage)
  • Then your total Current Liabilities are $575,000.
  • Then we take the Current Assets $625,000, subtracted from Current Liabilities ($575,000), and we end up with $50,000 in Net Working Capital.

Still not a bad number for a small business. However, when the bank CFOs view the Net Working Capital, it is in terms of the debt to asset ratio. They look at the Current Assets divided by Current Liabilities. In our example, the ratio would be 1.08. That means your working capital is just letting you tread water, and you’re probably being chased by some bill collectors. Banks will be hesitant to loan because you just don’t have much room for error (and they don’t want to be one of those bill collectors chasing you).

This index, also called Current Ratio, should be at least 2.0 – 3.0 for the business to operate smoothly. Anything below 1.0 creates a rocky road for the business.

What to do if you don’t have enough working capital? You can either find an investor (who will usually take equity) OR find money from inside the business. The latter is the best solution for most business owners and where Business Finance Corporation can help. We don’t look at your Current Ratio as much as we look at the quality of your client base. By looking at your client’s ability to pay their invoices, we develop a formula for purchasing those receivables on a percentage basis called factoring. By reducing the accounts receivable by half, in the example above, you could add nearly $185K to the cash on hand figure and may not need that loan to take advantage of the expansion opportunity.