The basic definition of working capital is current assets (cash, accounts receivable, inventory, marketable securities, prepaid expenses and any other liquid assets that can be readily turned in to cash) less current liabilities (accounts payable, accrued liabilities, short term debts).
Working capital is a measure of both a company’s efficiency and its short term financial health.
Working Capital Ratio = Current Assets ÷ Current Liabilities.
The working capital ratio indicates whether a company has enough short term assets to cover its short term debt. A declining working capital ratio over time could also become a major concern warranting further analysis.
If a company’s current assets do not exceed its current liabilities, it could have difficulty paying back creditors in the short term. The worst case scenario is bankruptcy. Many problems could occur with slow A/R collections, declining sales, slow paying customers, money tied up in inventory, all of which signal underlying problems in the company’s operations.
When you are buying a business, working capital is an important consideration. In addition to the purchase price you must factor in your working capital needs upon closing and taking over the company and beyond. I see many buyers who do not calculate working capital into their business plans and projections. Often times it leads to being undercapitalized as they embark on their new journey. The SBA states that “undercapitalization is the #1 factor for loan failures.”
Another working capital formula when purchasing a company is to analyze the amount of funds you will need for at least 30-90 days to operate your new business. An analysis of the A/R and A/P cycles will typically determine the amount of coverage in days you will need.
Cost of Goods Sold (COGS) ÷ 365 x 30-90 days + Selling/Administration Expenses + Debt Payment – Anticipated Revenue for the Period = Working Capital Needed.
Lenders will routinely include your working capital needs into your business loan package, providing you with the cash you need immediately to be amortized over the term of the loan.
As always, seek out professional advice when calculating and analyzing your work capital needs. Taking the time to properly plan for cash flow will ultimately lead to a successful transition and future operations of your company.Article at: Working capital is vital when purchasing a business - Special - southcoasttoday.com - New Bedford, MA
For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at eric@edisonavenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.buysellflbiz.com.
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