All businesses, regardless of their sector, need working capital.
For online sellers, however, this idea takes on added significance.
The amount of working capital available to a company is a key factor to consider when planning for growth and maintaining operations over the next 12 months.
As such, online sellers need to know how to assess their working capital numbers to find areas to unlock potential growth opportunities and secure working capital financing if necessary.
Continue reading through this guide as we cover what working capital is, why it’s crucial for an ecommerce business, and when you should pursue getting working capital financing.
Working capital is the cash balance showing the difference between current assets and liabilities.
It is the sum of money you expect to have after paying all your bills and making all your purchases over the next 12 months.
This can be a positive or negative amount (a crucial delineation that we’ll discuss more in this article).
A positive working capital amount indicates that short-term assets exceed short-term liabilities, while a negative amount indicates that revenues fall short of expenditures.
In other words, by monitoring the company's performance throughout the current financial year, you can ensure its continued viability and growth prospects.
Merchants can benefit from working capital because it allows them to anticipate and prevent growth obstacles and put idle funds to better use.
Here are the top two advantages you can anticipate from it:
A company's working capital level is a simple measure of its ability to meet short-term cash needs.
Why does this matter?
Here are three ways in which your company could suffer if you don't pay attention to your working capital:
Overall, merchants want to have enough liquidity to navigate the ebbs and flows of the business in the short term while keeping a focus on long-term growth.
And while some online retailers are able to handle their working capital needs on their own, the vast majority will seek out working capital financing.
Similarly to short-term liquidity, a company's working capital is a crucial component of business expansion and investment plans.
It can help secure a cash injection from external financing sources rather than drawing down on your cash flow.
As a result, working capital enables online merchants to:
✔️Entering new markets
✔️Shore up their existing positions
✔️Expand their product offerings
✔️Foster an optimistic outlook for future expansion.
Before an online seller decides to take on working capital financing, it’s helpful to get a good grasp of their current working capital levels to determine what the best solution could be.
These are the 4 factors to take into account while calculating it: the working capital equation, ratio, and negative and positive working capital.
The equation to calculate working capital is very straightforward.
Total all your current and short-term assets, and subtract the total short-term liabilities from this sum to get your working capital.
Any asset that can be quickly and readily turned into cash within the next 12 months is considered a short-term or current asset. Typical examples of current assets are:
🎯 Inventory – List of goods and materials, including quantity and costs associated with it.
🎯 Cash balance – Amount of funds a business has available.
🎯 Accounts receivable – Amounts that clients owe a business for products and services they received on credit.
🎯 Prepaid expenses – Employer-paid wages, bonuses, commissions, and other expenses.
🎯 Short-term investments – Investments that are expected to be converted into cash or sold within one year or less. Here are some frequent examples:
✔️Rent and utilities
✔️Materials and supplies
✔️Accrued income taxes
For further analysis, we can look at the working capital ratio.
And knowing the cash balance of your company's working capital is a solid starting point.
The formula for calculating your working capital ratio is as follows:
Working Capital Ratio = (Current Assets - Current Liabilities) / Total Assets
Generally, this figure will range anywhere from 0.5 - 3.
For instance, if there’s more cash coming in than going out, you will have a ratio greater than 1.
In comparison, in a situation where there’s more cash going out than coming in, the ratio will be less than 1.
Working capital numbers can naturally vary from quarter to quarter, or even month to month, as each of these metrics merely provides a snapshot of the company at a certain point in time.
Plus, a working capital ratio will look very different for an early-stage ecommerce store compared to one that has a five-year business history.
Regardless, the working capital ratio is a valuable metric that can guide businesses in the short term.
Continue reading below as we dive deeper into how you can analyze your company’s working capital ratio to make informed business decisions and gain valuable insights.
When a business has more current assets than current obligations, they have positive working capital. This means the company has sufficient liquid assets to meet its current and near-term obligations.
So what does a positive working capital tell you about your ecommerce business?
This means you have more cash coming in than going out and have a working capital ratio greater than 1.
This is beneficial for ecommerce business in 3 ways:
✔️ Your present assets are sufficient to cover your immediate financial obligations.
✔️ You could approach conventional lenders about securing more financing.
✔️ You can save money on inventory purchases, which could increase your earnings.
This indicates successful operations, yet it's not desirable to have a ratio that's excessively high.
If your working capital ratio is greater than 2, for instance, that suggests your assets exceed your liabilities by that amount.
This might look like a good position at first glance, but you should look deeper. Here are examples of 2 possible scenarios:
1. Low cash levels and high ratio – You may be holding too much inventory, not collecting receivables fast enough, or paying vendors too soon. This can result in a financial shortage in the upcoming months.
2. High ratio and a large cash balance – You can invest in your business and grow by expanding product lines or entering new markets.
Now let’s consider the case where your ecommerce store has negative working capital–or more money going out than coming in and a ratio below 1.
When a corporation has more current liabilities than current assets, it has negative working capital.
To pay its short-term obligations, the corporation will have to dip into its cash reserves or seek external financing.
A business with negative working capital may be struggling financially and may be at risk of defaulting on its debts.
Once again, further research is required to establish the root of the problem and the urgency of finding a financial resolution, because a company with negative working capital may:
🚫 Miss profit opportunities.
🚫 Not be able to buy products at cheap rates because suppliers may need upfront payment.
🚫 Have trouble paying its suppliers on time, resulting in late fees and client loss.
However, it's important to remember that many ecommerce stores have seasonal patterns. Thus, it may be normal to have a lower ratio when your orders move quickly out the door and your payables to vendors pile up.
As a result, you should monitor your working capital trends to determine whether a negative figure is transitive or prolonged before you begin searching for a solution.
Merchants may wonder how working capital differs from cash flow. Although they may appear similar from the outside, there is an important distinction between the two.
Working capital and cash flow provide different insights about your business:
Let's look at working capital and cash flow through the lens of the cash conversion cycle's many stages:
📌Days sales outstanding – Average time period for collecting receivables.
📌Inventory days on hand – The average time inventory spends on the balance sheet before being sold and turned into receivables.
📌Days payable outstanding – A company's average trade creditor payment delay.
The faster a company can turn its money into something that can be used, the better. Businesses with a shorter cash conversion cycle:
✔️ Have more cash on hand.
✔️ Can better weather economic storms.
✔️ Are less likely to be affected by the failure of financially weaker companies in their ecosystem.
After calculating its working capital, you can tell if your company has a positive or negative balance.
Working capital in surplus can indicate sound fiscal management and self-sufficiency.
Yet, depending on the factors at play, you may still be in a financial bind the following year.
On the other hand, a cash flow shortfall could cause havoc in the day-to-day operations of your organization if the numbers are negative.
The nature of running an online store usually means that working capital is either negative or very variable.
For this reason, it is common for such businesses to seek external investment so that they can worry less about meeting their immediate financial obligations and more about making use of chances for long-term growth.
Asset-based financing companies, such as Myos for instance, can help you improve your working capital levels in a short timeframe and enable you to quickly act on growth opportunities.
Myos provides a straightforward option for businesses in search of immediate access to working capital.
Financing with Myos brings the following benefits:
💡Safer and flexible financing.
💡No personal guarantees or credit history.
💡Only goods as collateral.
💡Product analysis is included.
And we employ an AI system that considers the following factors while evaluating the quality of your products:
The procedure for using Myos is simple:
2️. Determine your financing needs (stock, planned, or existing orders)
3️. Add products and deliver sales data.
4️. Add account data (company information and legitimation)
5️. Confirm your request
Your project request will be reviewed within 72 hours. Accepting the offer is the final step before receiving your funds.
Get your first non-binding, free offer to start building a risk-free foundation for the future growth of your business.
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