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Working Capital: Why Is It Important and How to Calculate It?

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Working Capital: Why Is It Important and How to Calculate It?

The general definition of working capital is the funds required to meet the regular expenses of a business. Such costs include utility bills, rent, wages, etc.

It is also sometimes known as net working capital, i.e. your gross working capital minus your current financial liabilities. Gross working capital is the total current assets of a business.

Current assets are those assets that can be converted into cash within one year. These include accounts receivable, finished goods, inventory, etc. Current liabilities are accounts payable, income tax, overdrafts, etc.

Importance of working capital

Working capital is crucial for the continuation of business operations. Hence, businesses opt for a working capital loan when faced with a deficit.

Some of the reasons working capital is important to include:

  • Continuous production cycle

Manufacturing companies must maintain an uninterrupted production cycle to ensure their business stays operational. They can follow some useful tips to manage their working capital efficiently. On the other hand, low working capital will decrease its liquidity.

  • Improves liquidity position

Liquidity is a business’s ability to convert its current assets to cash. A continuous flow of working capital ensures that the liquidity and solvency position of a company is high.

  • Guarantees payment of regular expenses

Working capital is crucial as it ensures a business can pay off the day-to-day costs mentioned above.

Also, debtors are paid off in due time if a firm has adequate working capital. Doing so not only increases its goodwill but also may enable the company to earn discounts from suppliers.

  • Ability to avert a crisis

Working capital can make or break a business; it is vital to tackle situations like a financial crisis or an economic downturn.

NBFCs provide working capital loans which come to the rescue especially in such situations. Also, an adequate flow of working capital can help a firm avail a high-value business loan with ease.

  • Regular dividend payments

A public company is obligated to pay dividends to its shareholders regularly. Hence, it needs to have ample working capital to make sure such payments are dispersed accordingly.

  • Proper utilization of fixed assets

A business with a regular working capital can make use of fixed assets accurately. On the other hand, such assets will stop operating if working capital is low. Also, firms will incur depreciation and interest unnecessarily on idle fixed assists.

Hence, working capital is essential to maintain all the above. Businesses can opt for a working capital loan in case the same is low to avoid critical scenarios.

Features of working capital loans

  • Ample financing to meet the short-term deficit

NBFCs can provide Working Capital Loans of up to Rs. 30 Lakh that can help businesses to address their working capital deficit.

  • Quick approval that helps in emergencies

Customers can avail these loans within 24 hours. Hence, working capital loans can help businesses out during critical funding needs.

  • Convenient and flexible repayment tenors

The repayment tenors for a working capital loan ranges from 12 to 60 months. Usually, the total interest payable increases with longer tenors and vice versa.

  • Only a few documents required to apply

Applicants only have to provide KYC documents, proof of business, relevant financial documents, and bank account statement to apply for these loans.

  • Minimal eligibility criteria to fulfill

Businesses have to be at least 3 years old and file income tax returns for at least the previous year before applying for working capital loans.

Other than the above, the business loan interest rate is also competitive making it affordable for small businesses.

Working capital loans are a vital and popular financial tool for small businesses. Such advances provide the necessary financial assistance in times of need to help a business meet its short-term goals against a comparatively nominal long-term financial liability.

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