How can an SME arrive at its working capital requirement?

Working capital is essential for any company’s growth. Good working capital ensures that company is running an efficient business line and with a high scope of continual growth.

Working capital may sound like a very simple term for an SME, but it’s not as simple, and doesn’t apply across businesses in the same manner. Let’s simplify the term Working capital for our better understanding.

Working capital = Current Assets – Current Liabilities

Now there is another parameter called Current ratio which gives you an indication of your SMEs working capital state. Basically, current ratio is what determines the ability of whether your SME would be able to manage the working capital in a healthy manner or not. So let’s understand now what a Current ratio is.

Current ratio = Current Assets / Current Liabilities

Current ratio value helps assess the ability of an SME or company to be able to pay back its liabilities (debts and accounts payable) with its assets (cash, accounts receivable, inventory).

• Current ratio of less than 1, indicates that the company’s ability to pay off the liabilities with its set of assets is in question. But this also does not mean that the SME might go bankrupt. This is indicative only, for an SME to go back to the working table with paper-pen and re-evaluate.

• Current ratio between 1 to 2 indicates a balanced health of the company.

• Higher current ratio though, something that’s 2+ also doesn’t indicate good health of the SME. It may mean that the assets haven’t been utilized well by the SME, to further expand the business and grow the revenues.

Again, current ratio is just one of the many indicators to assess the position and risk appetite of a company, and not the only indicator.

So, what’s the importance of working capital for your SME and business. Working capital actually reflects the operational efficiency of your SME. It helps maintain smooth operations of the SME. Working capital is essential for the following reasons:

• Smooth operational running of the business. For handling the day to day operations like raw material procurement, infra maintenance expenses, workers’ salaries/wages etc.. To handle all these expenses, working capital is an essential requirement

• Capability to handle the unexpected expenses. Healthy working capital means you have adequate funds to handle any expected expense or sudden cash requirement of the SME

• Good will of the Company. Good working capital means the ability to be able to make timely payments to the supplier and employees/workers, and hence building the good will of the company.

Above pointers do clear our minds around the fact that working capital is indeed necessary for the smooth running of an SMEs business.

Let’s now understand, how we can arrive at the working capital requirement of your SME. Below are few key indicators to arrive at the Working capital requirement of your SME:

• Industry type – The type of industry that you belong to matters a lot with the working capital requirement that you may have. Services industry working capital requirement would differ a lot from the manufacturing sector. The fundamental difference in this case, being that, in services industry you don’t have the need to manufacture a tangible product, which means you don’t have any requirement to purchase the raw material.

• Credit cycle – The number of days credit that you can receive from your supplier and the credit days that you offer to your customer, together help you arrive at your working capital requirement. it depends on the number of days credit cycle that you can manage from your supplier vs. how many days credit cycle can you offer to your customer. If you are able to get enough number of credit days from your supplier, to convert the raw material in finished goods and on the customer side, get an advance payment from your customer to supply the finished goods, as an SME you will be able to manage a very good working capital flow.

• Business growth plans – If you get a big business order or you would like to expand your business, in that situation having a good working capital flow becomes very critical. In absence of the same, you may end up losing out on that big order or the business expansion plan.

• Seasonal/unexpected requirements – certain products or services have a seasonal peak of their demand in the market. In such cases, during the peak time, if your working capital flow is not good, you will not be able to encash the seasonal demand, and lose out on the revenues. As an SME owner, if you have thought of this in advance by studying your market conditions, and have managed to keep the working capital flow good enough to cater to the peak demands, you are managing your working capital well

These are few of the important criteria, based on which you can arrive at the working capital requirement for your SME. Firstly to be able to arrive at, and then plan to have a good working capital flow is one of the most critical part of running good business. This is a crucial step for your SME to be able to stay operationally positive and have further avenues to grow your business in future.

Once you have arrived at your working capital requirement, you may also take help from external sources like NBFC or new age fintech startups like us – OfBusiness. You may write to us and we will be more than happy to connect back with you, and guide you better. Just submit your credit application today and enjoy better growth opportunities. Reach out to us at 1800-102-9586 or mail to contact@oxyzo.in