6 Ways Working Capital Is a Sign of Financial Health

//6 Ways Working Capital Is a Sign of Financial Health

The financial health of any company in any industry is determined by its working capital, which is defined as our current assets minus your current liabilities. Your company’s net working capital is a signal of your overall financial health and could be a sign that your firm will remain in business or not. Here are six ways your financial situation spells trouble or salvation for your business:

  1. Liquid Cash – A company can incur all sorts of debt and still remain healthy if it has enough liquid cash on hand. This is the amount of capital that you have access to at a moment’s notice. Check your bank balance. Do you have a cash reserve? If you have enough cash to sustain your business for the next five years, your in great shape. If you can sustain your business for two years, you’re doing okay.
  2. Accounts Receivable – Even if you don’t have a lot of cash laying around, your business could be healthy if it has a lot of accounts receivable. This is a measure of how much business you are doing and the number of clients you have working with you. But you still have to collect what they owe.
  3. Accounts Payable – On the liabilities side, if your accounts payable outweigh your accounts receivable, then you are spending more money than you make. That’s not a healthy position to be in, even if you have large cash reserves.
  4. Wages – Employees are necessary, but if your payroll expenses are too large to justify your earnings, you could be in trouble.
  5. Taxes and Licenses – Remembering the old adage about death and taxes, you need to include your tax liability, as well as any required licenses, in your company’s financial health calculations. Like wages and other expenses, taxes can eat away at cash reserves quickly.
  6. Debt – Debt, especially long-term debt, can have a business strapped. Take a long and hard look at your debt-to-revenue ratio to see if you might be in trouble now or in the future. Some unexpected business losses piled on top of heavy debt could kill your business quickly.

Of course, these are not the only measures of financial health, but they are tell-tale signs. If you have property and inventory that you can easily and quickly unload for capital, you can include that on the assets side of your balance sheet. In order to maintain solvency long term, a business’s total assets should outweigh its total liabilities. Short-term, you may find there are periods where liabilities may outweigh assets, but you don’t want to operate that way for long durations of time. A healthy business has working capital, which allows you to grow and expand, activities that require capital expenditures, as you continue to operate your business and manage your core competencies.

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