As a product seller, you can use many metrics to see how your business is performing. Gross profit margins, conversion rates, and customer satisfaction are important, but you also need to know what resources you currently have — your working capital.
Once you calculate your working capital figure, don’t just compare it with companies of all sizes and industries, as it might not be relevant. Instead, you should look at the true value of working capital for small and medium-sized businesses in your industry, whether it’s manufacturing, retail, or both.
Here’s all you need to know about working capital and its benefits for product businesses:
Working capital (also called net working capital) is the metric showing your company’s current assets after subtracting its current liabilities.
It’s the amount of money (or other assets) you have left over after your operating expenses are covered.
It’s closely related to short-term liquidity, which is your company’s ability to gather enough money in the short term to pay for upcoming liabilities (e.g., short-term bills like utilities).
So, what does the working capital formula tell you? The cash value or ratio you get says a lot about your company’s short-term financial health.
Whether the result is expressed as a cash value or a ratio, it’s generally advisable to have positive working capital. While a negative working capital is possible and could mean that a business is experiencing financial difficulties, it isn’t always a bad sign.
For example, Amazon sellers might buy (or produce) lots of stock to prepare for Prime Day, temporarily dipping their working capital into the red and hoping for a quick turnaround from large sales.
You can use working capital to fund your day-to-day operations, like payroll and stock purchases. It can also be saved for larger purchases later on.
Before calculating your working capital, you’ll need to review your current assets and liabilities. These sound straightforward, but some details, like the difference between current and non-current, can be complex.
Your current assets, also known as gross working capital, are your company’s short-term assets. In this context, short-term assets mean that you must be able to convert them into cash within a year.
Current assets can include:
Your company’s financial statements show your current liabilities, which are short-term obligations you need to pay within a year. You should closely monitor them and make sure you have enough money to pay them off.
If you don’t, you risk paying additional fees and damaging your relationships with suppliers and customers. If current liabilities are large and unexpected, like sudden surges in utilities or rush fees for stock, your daily business operations could be at risk.
Examples of planned current liabilities (short-term liabilities) include:
You shouldn’t include non-current assets and non-current liabilities in your working capital calculations.
Non-current (long-term) assets include:
Non-current (long-term) liabilities include:
Once you know your current assets and current liabilities, it’s simple to calculate your working capital. Here’s the standard working capital formula:
Working Capital = Current Assets – Current Liabilities
While the working capital formula is relatively straightforward, accuracy is essential for it to be meaningful.
Start by investing time in finding out your current assets and current liabilities, especially if you have a lot of inventory in different places.
For example, tracking inventory on spreadsheets requires double- and triple-checking data before and after manually transferring inventory information into your accounting spreadsheet or program to ensure accuracy.
Even a small error, like an extra zero, could have serious repercussions for your business. If you think you have more current assets than you actually have, you might overspend considerably and be short of cash for an unexpected expense.
Underestimating your current assets can also cause issues like underestimating your working capital. As you increase your sales channels, problems due to stock inaccuracies are common, and an undercount could lead to unnecessarily reducing spending and slowing your business growth.
To get the most from your working capital, make sure you can trace your inventory through its entire lifecycle. A good inventory management approach starts with manufacturing and warehousing, and it follows your stock right up to the point of sale (POS).
If you don’t have the time or resources to manually chase your inventory in an endless game of cat and mouse, consider leveraging Cin7’s automation and reporting features to ensure you’re not getting left behind.
Let’s walk through the process of a working capital calculation with sample numbers.
First, calculate your current assets:
Next, collect information on your current liabilities:
From your current assets ($380,000), take away your current liabilities ($240,000). This gives you a working capital total of $140,000.
Your working capital ratio (also called current ratio) is another helpful metric and an alternative way of expressing your working capital.
To calculate your working capital ratio, use this formula:
Working Capital Ratio: Current Assets / Current Liabilities
Using the numbers in our working capital example above, your working capital ratio would be 1.58.
Current Assets ($380,000) / Current Liabilities ($240,000) = 1.58.
In general, a good working capital ratio is between 1.5 and 2. However, this depends on your business and industry. For example, companies with large inventories tend to have lower working capital ratios. Walmart recently had a working capital ratio of 0.83, and Target had a similar 0.86.
Maximizing growth opportunities requires paying attention to the close relationship between your working capital and stock. Here’s what optimized levels of stock and working capital can do for you:
Inventory is a significant figure on any product seller’s balance sheet. As a valuable asset, it can provide the working capital you need to continue operating your SMB and grow it.
For your physical stock to function as working capital, levels must be optimized so that you have enough items to satisfy customer demand but avoid depleting your cash reserves for upcoming expenses.
If you buy too much stock and it expires or becomes last year’s model before it sells, you may need to cut your losses and throw it out or sell it at a loss. That results in less working capital to spend on high-value goods that sell quickly.
Holding on to low-performing stock or overstock that probably won’t sell within a year can also affect your ability to cover short-term expenditures by converting inventory into cash quickly.
If your working capital covers all your company’s current liabilities, you’re in a good position to buy stock as needed. By contrast, if your working capital is low, you might not have sufficient funds to buy new stock or order raw materials.
Inventory management software like Cin7 gives you real-time stock counts for all your business locations, helping you place orders when needed and preventing stockouts.
When done right, your working capital calculations help optimize your accounting practices and plan for the future. For a product business, this accuracy starts with your inventory levels.
To get a complete picture of your company’s financial health, combine your inventory and financial data using Cin7 and its robust accounting integrations, including QuickBooks Online and Xero.
Without enough cash on hand, you might need a loan to cover business operations like extra expenses from sales surges. Keeping sufficient working capital and practicing good inventory management creates strong cash flow so that additional loans aren’t needed to cover extra business expenses.
Managing working capital helps you pay your invoices quickly and avoid delays in stock deliveries. You may also benefit from bulk or early payment discounts from some suppliers.
When tax season comes around, the IRS won’t accept payment in sweaters, coffee tables, or business acumen.
To take the worry out of tax season, make sure every SKU in your current assets can be easily converted to cash. If you notice some stock gathering dust, adjust your product offerings to free up working capital
The past decade taught all of us that businesses must be able to adapt to economic shocks. Strong working capital will allow you to keep staff and valuable inventory during downturns or pivot to new product development.
For product sellers, inventory management and working capital management go hand-in-hand. It’s a delicate balancing act between keeping enough inventory and cash on hand.
If you have too much inventory, you might not have enough cash for unexpected bills. But holding too much cash risks stockouts.
Strong Inventory management can help boost working capital in the following ways:
With a few simple changes to warehouse operations, you can optimize your company’s use of storage space, reducing your spending on rent and labor.
For example, with optimized warehouse space, you can reduce the time warehouse staff spend processing, picking, and packing orders. In many cases, our warehouse management feature can reduce walking time during picking by up to 40%.
With faster warehouse processes and reduced costs, Cin7 helps you free up working capital to spend on other business aspects, such as marketing and new product development.
Instead of waiting for yearly physical inventory counts, you can get real-time snapshots of inventory performance. Using Cin7, you can quickly find the cost of goods sold (COGS) based on changing expenses, such as raw materials, overhead, and labor.
With this information, you can make adjustments to your products’ selling prices to boost your working capital.
Cin7’s inventory management software helps your purchasing department make more accurate purchases based on sales forecasting and avoid over-ordering.
By using inventory management software like Cin7, you can get accurate product data, such as historical and current sales. This will tell you how quickly your inventory can be converted to cash.
When your automated Cin7 reports identify slow-moving products, you can easily earmark them for SKU rationalization. By narrowing down your products to only high-value, high-performing stock, you have an inventory amount that better represents your working capital value.
Need help finding out the true value of your inventory for your working capital calculations?
Instead of depending on manual counts and data from unconnected accounting systems, get accurate and up-to-date information from Cin7’s Core or Omni inventory management software.
With our proprietary Connected Inventory Performance, you can easily track your inventory wherever it lives. You’ll also get access to our robust integrations, giving you accurate, up-to-date data on accounting metrics such as working capital, the Cost of Goods Manufactured (COGM), and the Cost of Goods Sold (COGS).
Schedule a demo today to discover how our features and integrations can help keep track of working capital.
