Working Capital and Business Liquidity – What’s the Difference?
Although they are often confused, business liquidity and working capital are two different but equally important financial factors for business success. As a business owner, it is important that you have a clear understanding of each and how to manage them. While veteran business owners may have a handle on this, improper cash flow management is what gets many entrepreneurs in trouble. Let’s start by defining working capital and business liquidity.
Working capital is defined as current assets minus current liabilities. If your business currently has $250,000 in assets and $175,000 in liabilities, your working capital is $75,000. In addition to cash, current assets include accounts receivable, inventory, and any short-term investments. Current liabilities include accounts payable, short-term loans, and other accrued expenses such as payroll or interest.
Business liquidity is directly related to your current assets and the ability to quickly turn them into cash. These are considered liquid assets. Liquidity allows you to pay current liabilities when they come due. Not only is it necessary for a business to continue daily operations but to promote growth.
Positive and Negative Working Capital
When a business has enough cash or liquid assets to pay all of its current liabilities, it has positive working capital. How much working capital is needed varies from business to business. The ideal amount of positive working capital will cover current liabilities with enough excess to invest in business growth. Negative working capital is when your cash and liquid assets aren’t sufficient. Liabilities become past due and the business’s ability to sustain itself falters.
Increasing Working Capital and Business Liquidity
To improve your business liquidity, you must first take steps to increase your working capital. There are a few different ways to do this.
Accelerate Accounts Receivable
This simply means you need to get your customers to pay you quicker. You can encourage this by offering a small discount for early payment. You should also evaluate your invoicing process. Customers should be invoiced immediately upon receiving goods or services. Even waiting a few days before sending out invoices means it will be that much longer before getting paid. You can also reduce the amount of past-due receivables by conducting thorough credit checks and levying late fees. You can sell invoices to a factoring provider and get funds already owed to you before the payment is due. This is known as invoice factoring and is a great way to convert outstanding invoices into cash.
When was the last time you evaluated your business operations? If your business is running inefficiently, it’s costing you money and decreasing your working capital. By streamlining business operations, you can reduce payroll expenses. You need to take a long hard look at your long-term assets. These are typically business equipment or investments that aren’t vital and could be sold.
Secure Business Funding
Even if you are effectively maintaining a high level of working capital and business liquidity, that doesn’t mean your business will never experience a gap in cash flow. When that happens, you’ll want to secure funding as quickly and efficiently as possible. A great way to do this is to establish a relationship with a lender and apply for funding before the need is urgent. It’s like using a credit card not because you don’t have the cash, but because you want to build your credit. With an established relationship backed by a strong payment history, you will have no trouble securing funding when you need it most.
As previously mentioned, the health of your working capital has a direct impact on your liquidity. By taking the necessary steps to improve your working capital, increased liquidity will almost certainly follow. It can help to delay the payment of liabilities until they are due and wait to invest any of your working capital in business growth until you can do it comfortably.
At CapFlow Funding Group, We Get It
Maintaining your working capital and business liquidity is crucial, however, most businesses will experience a gap in cash flow at some point. When this happens, the CapFlow Funding Group can help. We specialize in invoice factoring and can help you determine if it is the right option for your business. We are dedicated to helping our clients find the best funding solution and can also connect our clients to options such as purchase order financing, inventory funding, and merchant cash advances. We service many different industries with a variety of funding needs. Contact us today or apply online. Get the cash you need to keep your business moving forward.