If you’ve been following our posts for a while, you already know that we believe in demystifying finance for startups and early-stage companies. We love numbers but you may not. The thing is that staying on top of your company’s numbers does not need to be difficult. Working capital for tech startups is no exception.
Plus, as a business owner, understanding your financial situation is essential. Without knowing your organisation’s finances, you can’t make sound decisions about any other aspect of the business. So, like them or not, you need to know your figures. We’re here to help you make sense of them, and this blog is no exception.
This time, we’re taking a closer look at working capital – another essential aspect of basic business finance.
What is Working Capital?
Basic business finance is largely governed by understanding three key financial statements: your cash flow statement, profit & loss, and your balance sheet. Your working capital is closely related to your cash flow, although they are not exactly the same.
Your working capital is the difference between your current assets and your current liabilities.
Working Capital = Current Assets – Current Liabilities
As a financial measure, working capital shows whether your business will be able to pay its bills that fall due within a year.
So far, so good. Now, let’s look at what “current assets and liabilities” actually mean in real-life terms. After that, we’ll show you an easy way to access all the information in one place without having to pour over spreadsheets.
Current Assets
The phrase “current assets” sounds a bit like accountancy jargon. In reality, it’s just an umbrella term for the money and goods your business currently owns or is about to receive.
This group of assets includes the cash you hold in a safe or in bank accounts. Then, there are unpaid customer bills that are about to be paid, making up your accounts receivable. Current assets also stretch to any finished goods you are keeping in stock, and they include raw materials. Adding all of those may lead to a figure that is higher than you would have initially thought.
Current Liabilities
Current liabilities are the sum of what your business owes. Like current assets, this group of financial obligations includes several different things.
One of those aspects is the bills falling due within a year. In addition, there are accrued expenses that need to be paid within a year and short-term loans.
Positive or Negative?
Having positive working capital shows that your business is financially healthy in the short term. You can pay incoming or expected bills, and you most likely also have enough to support future growth.
Negative working capital means that your business may need to borrow money to pay bills. In most cases, it also means there are no funds to invest in the company’s development. For a startup or an early-stage company, this can be a dangerous situation to be in. Additional borrowing leads to additional obligations. Before signing on the dotted line and committing to another loan, you need to be sure you can pay it off as the business grows.
For some businesses, negative working capital is not particularly dangerous. If you can generate more money through increased sales, for example, your working capital situation may improve quickly.
Seeing the Full Picture in One Place
Understanding both your company’s cash flow and its working capital will give you a good idea of the business’s financial health. But how do you access all this information without combing through spreadsheets?
Simple: by automating much of your bookkeeping and accounting (more about the difference between the two in our next blog), you can see your financial situation at a glance.
Bookkeeping and accounting software like Xero may not be able to replace qualified financial advice. But it certainly makes it easier to access the details you need through one single dashboard. Rather than having to compile information from different spreadsheets, the software automates much of the process.
Bank feeds match incoming payments with outstanding invoices. Accounts payable and accounts receivable are clearly visible on the dashboard. And running reports to see your working capital and other data requires a few clicks rather than hours of painstaking work.
This is how accounting and bookkeeping software simplifies numbers, even for founders and business owners who don’t like numbers. The point is that you don’t need to like numbers to understand them.
Final Thoughts
Knowing the state of your working capital is an integral part of understanding the financial health of the company. Negative working capital may raise red flags, but you can also use these red flags as an early warning system reminding you to act now.
Software like Xero helps automate much of the basic bookkeeping and accounting functions startups and early-stage companies need. Making use of dashboards and easy access to financial reports keeps you in the driving seat of the business, armed with all the financial information you need.
Got questions about working capital or about automating more of the financial aspects of your business? Get in touch! Remember, we love numbers.