• Business Growth & Optimisation

Working Capital: How Much Do You Need?

5 min. read07.07.2021
By Team Zeller

The working capital formula measures the short-term financial health of a business.

Knowing how to calculate working capital is an important step in understanding your business's potential for growth. It will provide a snapshot of whether a business has enough assets on hand to cover day-to-day operations and debt, as well as scope to scale.

Here we will detail what the term means, why it’s important to have a handle on it, and how to make it work for your business’s future.

working-capital-supporting-2106-0266

Working capital funds day-to-day operations, helps pay salaries, and covers other operating expenses.

Firstly, what is working capital?

Working capital refers to the cash you have on hand to keep your business operating, minus expenses.

The amount of working capital you have will provide insight into the current health of your business. It is similar to — but not the same as — cash flow, which refers to the ability to generate income over a period of time. A business with high cash flow will most likely have high working capital as well, provided outstanding debt or investments are under control.

An ideal amount of working capital is in line with or higher than other businesses of similar size. The ratio of assets to liabilities should always be positive, with a healthy ratio somewhere between 1.2 and 2.0. This means the business has more than enough liquid assets to cover upcoming debts within the year. A ratio less than 1.0 indicates more expenses than the money or assets on hand can meet.

If the ratio is too high it may indicate there is more that could be done to expand the business. If it’s too low, it may be a sign that your business is in trouble and you need to start increasing your cash flow.

How to calculate working capital

The formula for calculating your business's working capital is straightforward.

equation graphic (2)

Assets refer to cash, accounts receivable, inventory, and other assets that could be turned into cash within the next 12 months while liabilities could be things like accounts payable, wages, taxes payable, and long-term debt.

Large businesses can get by with negative working capital because of their experience in making revenue quickly, while small businesses should aim for positive working capital figures.

For example, imagine a business has $120,000 in assets in the form of their property ownership, physical inventory, and cash on hand. There's also $75,000 in current liabilities, to pay wages, utilities and taxes. This puts working capital at $45,000.

Why is it important for a business to know?

Business owners should keep track of their working capital as a way of ensuring they are on track to meet their financial targets and goals and stay afloat.

A Xero Small Business Insight report recently found that half of all small to medium businesses are cash flow negative through most of the year. This number was highest in the months leading up to Christmas and into January.

Different businesses will have different requirements for working capital, and some may need more than others, or require it at different times of the year. Whether your business will need high working capital is determined by three key factors: business type, operating cycle, and management goals.

Business type

The kind of services you provide will impact the amount of working capital you need to operate your business smoothly. If your inventory is mostly physical assets, such as retail, then a higher ratio of assets to expenses will be needed, to ensure there is enough stock on hand. This will increase at different times of the year, such as leading up to Christmas holidays, where you might need a cash injection to ensure you can keep up with demand and cover short-term expenses.

In the same way, tourism and accommodation businesses will need a significantly higher amount of working capital in the lead-up to busy seasons, such as Christmas, Easter and school holidays.

On the other hand, if your business deals in intangible services and not physical inventory such as consultants or online service providers, then the amount of working capital will most likely be lower.

Operating cycle

The time it takes to produce, deliver and receive revenue is another factor to take into account when considering your working capital needs. If the operating cycle is lengthy, high levels of working capital will be required to ensure expenses and short-term debts can be paid for during the periods when revenue isn’t coming in.

Likewise, if there is a time delay between the rendering of services and payment, you will need to have enough working capital to cover business expenses until you receive your takings.  That’s why a mobile EFTPOS machine is a critical tool for every business; it enables you to take payment from the customer on the spot, saving you from chasing up late payments and enabling you to access your funds quickly.

Ready to get started with Zeller?

Sign up now

Management goals

Depending on the short-term goals for your business, as well as how fast you are hoping to expand, you may have higher requirements for working capital. When growing your business you will have increased capital needs as you increase your investment in inventory and accounts receivable on top of costs dedicated to these expansions, including equipment or the costs of market research and other associated development expenses.

If your goal is to expand, there will be an increased need for capital. More money will need to be invested into growing your business, whether that be in infrastructure and additional inventory, or on the costs associated with market research and designs. Conversely, if you are no longer looking to expand, you will have a reduced need for working capital.

As a business owner, it’s crucial to have a good grasp on the amount of working capital available to you as a means to be able to further your business. Sign up to our Business Blog to be the first to receive tips on maximising your working capital.

How to structure a new business

Choosing the right legal structure is a crucial part of running a business. The business structure you choose will affect your legal obligations, tax, asset protection, and reporting obligations. Regardless of whether you’re just starting out, or your business is growing, it’s important to understand the options. While this article can’t advise which structure is best for your unique circumstances, it does explain the most common types of Australian business structures and key features of each. A sole trader is an individual trading on their own. In a partnership, income, losses, and control are shared among partners. A company is a legal entity, separate from its owner(s). A trust is an entity that holds property for the benefit of others. An association is an entity usually established for recreational, cultural or charitable purposes. Keep reading to learn more about the types of legal structures new business owners usually consider – as well as how your obligations may differ, depending on the structure you choose. Types of business structures Sole trader Entrepreneurs who want to run their business all on their own are likely looking at a sole trader, or sole proprietorship, legal structure. A sole proprietorship is easy and inexpensive to set up. It’s also arguably the simplest type of business structure, because no one else is involved. Below are some of the key features of a sole proprietorship (or sole trader) business structure. Sole traders use their personal tax file number when lodging their income tax return. Income reporting is simple — there is no separate business tax return, all income is reported in the sole trader’s individual tax return. Throughout the year, sole traders typically put money aside for tax time using Pay As You Go. Sole traders will need to register for Goods and Services Tax (GST) if their annual GST turnover reaches $75,000 or more. A sole trader can employ staff. A sole proprietorship is an ideal business structure for business owners who want to be able to make all the decisions. However, it goes both ways. Sole traders also take on all accountability in the event of hardship or lawsuits. If the business goes into debt, a sole trader’s assets could be under threat. It’s also difficult to raise capital, if you’re planning on growing your business, and sole traders can't claim a deduction for drawing money from their business. Many new business owners start out with this structure, as it is relatively simple to change legal structures if you’re starting from a sole proprietorship. The same cannot be said for switching from another legal structure. Partnership A partnership is a legal structure under which two or more people operate a business, distributing income or losses between themselves. Instead of a single person making all the business decisions and taking on sole responsibility, control over the business is shared among at least two — and sometimes up to 20 — people. Naturally, that means the risk is typically shared also. A partnership may be an ideal option for business owners who are willing to relinquish some control in exchange for more widespread accountability. Similar to the risk a sole trader faces, if the business goes into debt each partner’s assets may be under threat. Below are some of the key features of a partnership business structure. A partnership doesn't pay income tax on the profit earned. Instead, each partner is required to report their share of income in their own individual tax return — and pay tax on their share. An ABN is required for all business dealings. A partnership is required to have its own Tax File Number, and all income and deductions must be reported in an annual partnership return — which is lodged with the ATO. As above, if the business’s annual GST turnover is $75,000 or more, it must be registered for GST. A partnership is not required to have a written partnership agreement in place, however it’s a good idea to prepare one for obvious reasons. A partnership agreement outlines how income and losses are each distributed amongst partners, and helps ensure all partners are on the same page from the outset. Company In a sole proprietorship or partnership, the business owners are part of the business. A company, on the other hand, is its own legal entity. This separation means that operating a company comes with less personal risk. A company exists as its own legal entity. Below are some of the key features of a company business structure. Companies must have a TFN. Companies pay tax at the company tax rate. As above, if the business’s annual GST turnover is $75,000 or more, it must be registered for GST. A company must pay Super Guarantee Contributions (SGC) for any eligible workers. This includes the director(s) of the company. A company is more expensive to register than a sole proprietorship or partnership, and the reporting requirements are also more complex. Whatever money the business makes belongs to the company, instead of going to the business owners. This reduces the liability of shareholders when it comes to debt and lawsuits, but it also increases the amount of startup paperwork and red tape. One consideration to keep in mind is that a business set up under a company structure is easier to sell or pass to someone else, as it’s set up as its own legal entity. Trust A trust, like a company, is a legal entity. The difference is that it is established to benefit people outside of the organisation as opposed to bringing in a profit for shareholders. Below are some of the key features of a trust. A trust must have its own TFN and ABN. As above, if the business’s annual GST turnover is $75,000 or more, the trust must be registered for GST. Whether or not a trust is required to pay tax depends on the wording of its deed, and whether income earned is distributed to the trust’s beneficiaries. The profits of a trust are divided among beneficiaries, who then pay tax on the money they make. Incorporated Association An association can be incorporated, or unincorporated. When an association is incorporated, it becomes a legal entity in and of itself — protecting its members from legal liabilities. Incorporation is a simple and inexpensive process, making it an ideal way to establish a legal entity through which small, community-based groups can provide a service. An incorporated association is intended to do good for a community — typically by providing a recreational, cultural or charitable service to people  — rather than make a profit for shareholders. All profits are put back into the association’s activities, rather than distributed to those involved in the business. Below are the key features of an incorporated association. An incorporated association will usually have members, a committee, a public officer, and a registered office. The association can accept gifts, bequests and grants, as well as buy land, take out loans and sign contracts. An incorporated association can sue, and be sued. Members and officers will generally be protected against personal responsibility for any debts or liabilities incurred by the association, although they could remain personally liable for outstanding fees. An approved constitution must be in place, outlining qualifications for membership, quorums for meetings, provisions for elections, and more. Any profits made by an incorporated association are not subject to tax. There are a number of qualifications that must be met before an association can become incorporated. However, the governing legislation differs in each state or territory. Further information regarding this type of business structure can be accessed via the relevant state bodies . Choosing the right structure for your business Choosing a legal structure requires business owners to consider how much power they want over the decision-making process, as well as how much accountability and responsibility they are willing to take on. When structuring a new business, or restructuring an existing business, it’s critical to understand the extent of your personal liability — as well as tax implications. Make sure to schedule a time to meet with your financial and legal advisors to discuss which legal structure best suits your particular circumstances. Here are some additional resources to help you choose your business structure. Business Registration Service | Help me decide The Australian Taxation Office | Choosing your business structure The Australian Taxation Office | Overview of legal structures Business Victoria | Business structures Small Business Development Corporation (WA) | Choosing your business structure Business Queensland | Business structures Fair Trading (NSW) | Business structures Business Tasmania | Choosing a business structure SA Business Information Hub | Business structures Northern Territory Government | Business structures Please note this article is for educational purposes only. It does not provide legal, accounting, or tax advice.

Meet Zeller: we’re reimagining banking for Australian businesses

Accepting payments, managing your finances, and paying recipients should be simple. Unfortunately, this isn’t always the case. Our research shows the majority of Australian business owners are dissatisfied with their business banking. The truth is, most merchant services solutions aren’t built to help your business thrive. That’s where Zeller comes in. Today, we’re launching Zeller — giving Australian merchants affordable, accessible, and innovative tools that enable businesses to get paid, access their money, and manage cash flow — without ever having to set foot inside a bank. We’re reimagining business banking through powerful new technology, backed up by local support and personalised service. An innovative SME alternative to business banking “Innovative” isn’t a word usually heard in the context of merchant services. Finding integrated financial solutions to grow and support your business often requires you to weave together multiple products from different providers, which typically means longer processing times, more paperwork, and a more frustrating experience. Large enterprises benefit from financial solutions tailored to their specific needs; traditional banks have shown that they’re more than willing to pour resources into supporting big business. However, this comes at a cost to the everyday Aussies behind our small to medium sized businesses. SME owners are typically forced to fit the traditional banking mold, suffering through archaic onboarding processes only to be hit with high fees, lock-in contracts, and slow processing times when the paperwork is complete. For new business owners, this can present what seems like an insurmountable hurdle to starting and growing a venture. With 67% of businesses stating they would prefer a non-Big 4 bank, it’s clear that Australian business banking is fundamentally broken. A lack of innovation from the incumbents means merchants like you are overlooked and underserved, at a time when they should be thriving. Businesses need new tools, technology, and support to grow. And that’s why we built Zeller. What’s in the box Zeller is all-in-one payments and finance solution for Australian businesses. It helps to accelerate your business cash flow by giving you a next-generation EFTPOS terminal, a free business transaction account, and free business Mastercard, all in one box. 1. Zeller Terminal Our research revealed that 71% of business owners using clunky EFTPOS terminals regularly consider switching providers. High costs and expensive fees, slow deposits that impact cash flow, and a lack of local support are all common reasons for businesses looking to switch. The majority of Australian business owners are dissatisfied with outdated EFTPOS technology currently on the market. Zeller Terminal is an all-in-one card payment and EFTPOS solution. Our next-gen payment terminal allows you to accept every payment from every customer – Zeller Terminal accepts contactless devices, contactless cards, chip cards, magstripe cards, and will soon also accept alternative payment methods such as Alipay and ZipPay. As new payment methods continue to emerge and shape the way Australians pay for products and services, Zeller Terminal will adapt to support Australian businesses to grow. Read more about Zeller Terminal . 2. Zeller Transaction Account We understand that being able to effectively manage and access your cash flow is key to the long-term survival of your business.  That’s why we make sure your funds are available as quickly as possible after taking payment from a customer. Zeller Transaction Account is included free when you sign up for Zeller. Your account is instantly ready to use, giving you real-time visibility over your settlements and spending — no lengthy paperwork required. When you take payment through Zeller Terminal, funds are settled directly into your free Zeller Transaction Account within the day. You also have the option of sweeping your funds into any existing bank account, and they’ll be accessible as soon as your bank allows. Read more about Zeller Transaction Account . 3. Zeller Mastercard By giving you the tools to accept payments, store and settle funds, and spend your money, we're significantly reducing the time it takes for you to get access to your funds. According to the Australian Bureau of Statistics, more than 60% of small businesses close within their first three years — and the most cited cause for business failure is poor cash flow. As a business owner, fast access to your funds to pay your staff, suppliers, or buy product, is imperative. Read more about Zeller Mastercard . By seamlessly combining these services into a fully integrated solution, Zeller significantly reduces the time businesses spend on finding a merchant services provider, completing lengthy applications, getting set up, and connecting disparate payments and financial services solutions — all while speeding up your business’s cash flow. Watch the video to see how Zeller works in more detail. Your business, your way Merchant services should work the way your business needs, allowing you to pick and choose the business banking products you need to sustain and grow a profitable business. With Zeller, you have the option to choose the parts you need – Zeller Terminal, Zeller Transaction Account, and Zeller Mastercard work just as powerfully together as an integrated solution as they do alongside your existing products. Learn more about our EFTPOS machines and how our newly launched products are changing business banking for the better.

What’s the latest?

Fresh resources, offers and updates in your inbox every month, to help your business succeed.