This article includes tips, suggestions, and general information. We recommend that you always do your own research and consider getting independent tax, financial, and legal advice before making any important decision.
Your e-commerce fulfilment centre is bustling with inventory and employees. Expansion is rapid. But beneath the boxes and packing tape lurks a major problem: low cash flow.
Without the funds to cover daily expenses, business could quickly grind to a halt. Enter working capital. It’s the fuel that keeps the engine running. It helps a business to keep the lights on, meet financial commitments, and increase growth opportunities.
Whether you run a small start-up or an established operation, meeting your working capital requirement is important to realising your business ambitions for long-term growth and success.
Simply put, working capital is the difference between a business’s current assets and current liabilities. It’s an important metric that can help a company to maintain resources to manage day-to-day operations and short-term financial obligations.
The main components of working capital are typically listed on a company’s balance sheet. Broadly, there are 2 categories: assets, or money you have, and liabilities, or money you owe.
Current assets can be converted into cash within a year. That includes cash and cash equivalents, accounts receivable, inventory, and prepaid expenses.
Current liabilities refer to a company’s financial obligations due within a year, such as accounts payable, short-term loans, interest payable on loans, taxes payable, unearned revenue, and accrued expenses.
Subtract the current liabilities from the current assets, and you have the company’s working capital. A healthy working capital position is a great sign that a business can navigate challenges, seize opportunities, and achieve big-picture goals.
Fortunately, you’re not alone in your efforts to maintain strong working capital. PayPal can support with PayPal Working Capital cash advances that can help your business to expand and grow.1
A company’s working capital requirement (WCR) specifies the funds it needs to pay short-term operating expenses (production costs, payroll, rent) whilst maintaining liquidity, or a “cash cushion.”
For an online jewellery business, the WCR would include the funds needed to cover expenses such as:
When businesses closely monitor their WCRs, they can:
When calculating your working capital needs, examine these business expenses:
Timely bill payment is important to maintaining operational stability, avoiding late fees, and preventing service disruptions. Some businesses have simple bill structure, whilst others are more complex.
Take restaurants. Beyond costs like rent and utility bills, they manage frequent deliveries of perishable goods. This involves paying ingredient suppliers on tight deadlines with payment terms that vary according to market pricing.
Mismanaging payments could lead to more than just late fees. It could strain relationships, cause delays in deliveries, and interruptions in service.
For most businesses, payroll is one of the largest consistent expenses. Paying employees accurately and on time can help to keep morale high and operations smooth.
But managing payroll goes beyond bank transfers. It involves accurately predicting cash flow needs by:
Effective inventory management lets you meet customer demands promptly without tying up too much capital in unsold stock, which can lead to high storage costs. PayPal Point of Sale software can help you to track inventory by notifying you when stock is running low.
Beyond rent, utilities, and marketing, many businesses have industry-specific monthly bills vital to their functionality and growth. Restaurants lease high-end equipment. Tech start-ups need cutting-edge software. Photographers have travel expenditures. Car manufacturers need research and development.
Businesses have various opportunities when looking to reinvest working capital for expansion and growth.
A small bakery may use surplus funds to expand its production capacity, scaling its operations and exploring new growth opportunities through possible additional locations and sales points.
A healthy level of working capital makes that possible. And if your business has a PayPal Working Capital cash advance, a percentage of your PayPal sales will be automatically deducted to repay the advance over time.
Calculations may vary from business to business, but this is the formula commonly used to calculate WCRs:
(Accounts receivable + inventory) – accounts payable = working capital requirement
Interpreting the WCR involves understanding its value:
In addition to WCR, calculating working capital ratio can reveal the big picture of a company’s financial health.
The formula to calculate the working capital ratio is fairly simple: Divide current assets by current liabilities.
Whilst the ideal working capital ratio varies depending on the industry and a company’s circumstances, it’s typically 2:1 or higher to cover current liabilities twice over.
Effective working capital management is important to a business’s health and agility. These are common strategies:
Efficient inventory management may enable businesses to free up working capital. One example is using a just-in-time inventory strategy to order stock closer to demand periods. This may help to reduce storage costs and the risk of overstocking seasonal items.
Businesses may be more likely to support more-consistent cash flows when they have shorter payment terms for customers and longer payment terms for suppliers. This may enable a company to improve cash flow by receiving payment before bills come due.
Develop efficient strategies for forecasting and managing cash flow and allocating resources. It may significantly enhance your business’s ability to manage its working capital.
Conducting financial reviews may help you to anticipate cash shortages and surpluses. And scenario planning may help you to model and prepare for different and perhaps challenging financial situations.
Predict future cash inflows and outflows to get a clearer picture of your working capital needs. Businesses may be better equipped to set aside funds when cash flow is strong to cover expenses during slower months.
To more accurately forecast cash flow:
Cutting costs doesn’t have to mean implementing drastic measures or sacrificing quality. It can mean being mindful of expenses and finding opportunities for savings.
For example:
Even small changes can add up to major savings over time.
Debt is a reality for many businesses and needs to be effectively managed to maintain a healthy working capital position. This involves more than timely payments. It can also include managing debt to reduce interest costs.
Cash advances, such as those that PayPal Working Capital offer, can act as financial safety nets for businesses. Whilst lines of credit may be more attractive than short-term loans, which often have high interest rates, PayPal’s cash advances are based on your PayPal sales history and have no interest (just a fixed fee). Plus, there’s no impact to your credit score.
A good collections process can improve cash flow and strengthen a business’s working capital.
Tips to encourage prompt payment:
Outsourcing certain core business functions can free up working capital.
Hiring a third-party provider for payroll processing could eliminate the need for in-house payroll staff and payroll software. And it can relieve the burden of managing a complex process.
Another option is working with specialised customer service providers. They could potentially help your business to improve response times, enhance customer satisfaction and loyalty, and reduce staffing costs.
Running a successful small business requires a savvy balance of resources. Each business has its own unique circumstances. But understanding the implications of working capital levels can be a good first step towards maintaining business stability and growth.
If a company’s working capital ratio is lower than 1, its current assets may not be enough to cover its current liabilities.
Low working capital can lead to liquidity shortages, which may, in turn:
Short-term loans or lines of credit can help businesses to bolster cash reserves. PayPal Working Capital has issued more than £2.5 billion in business funding to 58,000+ UK companies over the past 10 years.2 And 93% of surveyed PayPal Working Capital customers reported that a PayPal Working Capital cash advance helped them to increase their sales revenue.3
A high working capital ratio means that a company has many current assets compared to its liabilities.
Excess working capital isn’t always better. It can indicate ineffective resource use. That could mean capital is tied up in unsold inventory. Or that receivables are collected too slowly. Either situation can reduce profitability. Or it could be that high working capital is necessary for a company’s particular situation.
Scale your business, optimise cash flows, and get help managing working capital with fast and flexible business funding.
Learn how PayPal Working Capital can help you to grow your business.