Estimating Working Capital to Fund Improvements

Every business has to be able to sustain a positive cash flow to stay in business. In a recession, that may mean barely squeaking by, and at other times, you will have a surplus of working capital you can use to fund improvements. When that doesn’t happen naturally, as a product of your existing business, it can be due to poor inventory and product lines, a need for capital improvements, and/or more emphasis on sales and marketing. You will need a loan. However, before you can figure out how much more money you need to fund improvements, your lender is going to inquire about your already established working capital to determine whether 1) You can pay back a loan, and 2) How large a loan you can support for improvements. Be proactive and find out first. It pays to hop online and visit a business loan calculator for your own calculations to determine what you want to ask for that can be approved quickly based on your ratios.

Working Capital Ratios

There are two very important ratios that your lender will review before making a final decision. They are the current ratio and the quick ratio.

• Current Ratio – The current ratio is basically just your current assets divided by your current liabilities. This tells a lender that you have enough current cash flow to manage to successfully manage you current liabilities. When it is above one, you have a positive working capital. If it is less than 1, you have a negative working capital, meaning that you can’t even support the debt you already have. Check the lender’s site and see what requirements they have for this number and do the math on your business calculator online, before you apply.

• Quick Ratio – This ratio is much more stringent and is typically referred to as the “acid test.” It consists of the sum of your ready cash or cash equivalents plus your accounts receivable and your marketable securities, all divided by your current liabilities. It measures the liquidity of a company instead of just your ability to repay your current obligations. There are also online calculators that will help you figure out the quick ratio of your company before you apply for a loan with this requirement.

Either one of these ratios can tell you whether you can support additional debt for working capital expansion or if you can easily liquidate something to help fund purchases or put up collateral also to get better loan terms.