How to control working capital to build more resilient startups

To make a business work, it is necessary to take small steps in the right direction. For high-growth companies, there are a number of metrics that can help them determine if they are on the right track. Among them is working capital, which provides information on the company’s capacity to meet the payments required on a day-to-day basis.

Proper financial planning ensures that entrepreneurs can deal with day-to-day operations and meet recurring payments, such as those to suppliers and employees, while developing their business with an eye on growth. A company’s liquidity is a thermometer with which to measure the financial health of the company, which is combined with other indicators, such as cash flows, efficiency or solvency ratios, to obtain a complete picture of the company.

What is working capital

The concept of working capital refers to the difference between the company’s short-term assets and its short-term liabilities. It is, therefore, an indicator that focuses on measuring the company’s situation over a time period that does not exceed 12 months.

It must be considered that a positive working capital is necessary to be able to meet the payments necessary for the viability of the company. However, this should not be excessively high: if too high an amount is earmarked, this capital is not being used for productive investment or to promote the growth of the business. Excessive working capital could also be, for example, an indicator that the company has too much unsold stock.

The formula for calculating working capital

The way to calculate a company’s working capital is relatively simple: current assets must be subtracted from current liabilities. This is a figure that will vary depending on the time at which it is calculated.

When calculating working capital, a series of steps must be followed:

• Identify current assets. Current assets correspond to what is also known as liquid or current assets. When referring to assets in the case of companies, the definition refers to goods, rights or other resources controlled by the company. Within this section there are some items that may be more liquid either because they are deposits in a bank account or because they are the ‘stock’ of goods to be sold. This type of assets are those included in the category of current assets, which can be converted into capital with which the entrepreneur can make payments in a flexible manner. In contrast to these, there are other assets, for example, an industrial building, which cannot be converted so quickly into cash.
• Account for current liabilities. Current liabilities correspond to the payment obligations that the company must face in the short term, also in a period of less than 12 months. This includes, for example, payments to suppliers, employee salaries or office rent.
• Subtract. In the case of a company with current assets of 35,000 euros and payment obligations of 15,000 euros, the working capital would be 20,000 euros.
• If instead of these figures, the company had 35,000 euros of current assets, but payment obligations of 40,000 euros, the working capital would be negative by 5,000 euros. Therefore, the entrepreneur would have difficulty developing the activity of their company.

How to improve working capital

BBVA Spark helps high-growth companies optimise their working capital in their daily operations. Maintaining adequate working capital will allow them to develop their activity more comfortably and to focus their efforts on improving their business.

As this is an indicator in which two items are subtracted to improve the result, the entrepreneur can choose to increase current assets or reduce liabilities if they want to improve working capital. It may also happen that the company needs to adjust both figures. If the entrepreneur has negative working capital, as in the previous example, they should review their numbers to find a solution adapted to their business in order to improve it. On the one hand, they can try to reduce or restructure the payments they have to make. For example, talking to their suppliers to find an invoice payment term that best fits their business. Another option is to try to increase their assets by improving income, increasing savings or boosting their financing.

The formula for calculating working capital will be of great help for entrepreneurs to be able to operate comfortably. This metric, along with the rest of the financial indicators, can help them detect the state of their financial health in order to continue on the path of growth.