Accounting Solver

SMALL BUSINESSES: How to determine Working Capital that will work 2

by ren on January 26th, 2008

If you do not put up enough money for Working Capital, you will be forced to incur debt or inordinately prolong accounts payable so that you get into trouble with your suppliers. Not having adequate Working Capital will place your business in an unsustainable cycle of debt.

After you have determined the amount you need for the fixed assets you have to acquire to be able to operate, you have to add to this amount what you need for Working Capital.

To determine Working Capital:

1 find out how much it takes to produce one unit of your product

2 estimate how many units you can sell within a period, say, a month

3 determine how long and how much it takes to produce the estimated units of products for sale (include delivery time for raw materials and, to be conservative, assume that you have to pay cash)

4 estimate how long it will take to convert your goods for sale to cash (i.e., collections)

5 determine how much you need to operate, i.e., overhead or operating expenses

6 calculate the length of time from the delivery of materials to collection of sales proceeds

7 multiply your overhead by the length of time determined in step 6

8 Add the result of step 7 to the result of step 3 (also multiplied by the length of time determined in step 6). This is the optimum level of Working Capital that your business should have.

If this is confusing or difficult to follow, email me (ren.garcia@yahoo.com) or leave a comment / query so I can clarify.

Image from Microsoft Clipart

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POSTED IN: Accounting Concepts, Accounting for NonAccountants, Best Business Practices, Equity / Capital, Small Business Finance, Success Accounting