What Is Operating Capital? (With Examples)

When you’re starting your own business, you’ll likely find that there are a million technical terms you need to be familiar with.

While you should always rely on experts to help you truly understand these principles, especially when finances and legal compliance are concerned, doing some of your own research can help you get a better baseline understanding of what other entrepreneurs and corporate leaders are talking about in your next meeting or networking event.

In this article, you’ll learn about operating capital and how to calculate it for your own business. Again, though, it’s always a good idea to check with an accountant before you make any major financial decisions for your company.

Defining Operating Capital

Operating capital, also called working capital or net working capital (NWC), is the money available for your business to keep it running on any given day. It’s the money you can use to buy inventory, pay employees, fix your facilities, or pay for anything else necessary to keep your company going.

In more technical terms, operating capital is the company’s current assets (anything that can be turned into cash within one year) minus its current liabilities (any obligations that will be paid off during a year).

Current vs Long-Term Assets and Liabilities

If you’ve been around the business world for some time, you’ve probably heard the terms “assets” and “liabilities” thrown around quite a bit.

However, what is less talked about is the difference between current assets of liabilities and long-term assets and liabilities.

Current assets refer to anything that can or is expected to be liquidated in a one year period of time. Current liabilities, similarly, are debts that are expected to be paid within one year.

Current assets can include accounts receivable, inventory, and cash, and current liabilities refer to debts such as expenses payable, payroll expenses, and annual rent or mortgage payments.

On the other hand, long-term assets refer to items like heavy machinery and property, and long-term liabilities include pension and post-retirement healthcare responsibilities and long-term loans.

However, the line between the two categories of assets and liabilities can get fuzzy in areas such as long-term loans. The loan itself, if it is to be paid off in an amount of time longer than a year, is a long-term liability, while the amount you’ll be paying off during just one year falls in with your current liabilities.

This minute difference is one of the main reasons why it’s important to check your work with a professional accountant when you’re calculating your assets and liabilities.

Why Operating Capital Is Important

Every business needs operating capital in order to run efficiently. Understanding how much operating capital your business has is vital to creating a budget for your organization and keeping tabs on its financial health. This is also often a number that investors and lenders will want to know before they get involved with your company.

Not having enough operating capital is a red flag that your business isn’t making money efficiently and that it may not have the resources to grow easily, pay back loans, or even, in worst-case scenarios, survive.

If you have too much working capital, though, this could also be a sign of trouble down the road since this often means that you aren’t investing enough of your company’s money.

Having good operating capital means you have more current assets than current liabilities, that you’re wise with your funds, and that you can grow your organization. It also allows your business to remain solvent in the event that it goes under.

How to Calculate Operating Capital

As you read earlier, your operating capital is your current assets minus your current liabilities. Here is what this looks like in formula form:

So, to calculate your operating capital, you’ll need to add up all of your current assets, add up all of your current liabilities, and then plug those numbers into the formula above.

If your answer is a negative number, you know you have a problem because that means you have more liabilities than assets. Whether that problem lies in your calculations or in your actual company finances, though, is the next question you’ll need to ask both yourself and an accountant.

Examples of Calculating Operating Capital

To help you better understand how this formula works, here are a few examples of how you’d calculate operating capital for a business.

How to Manage Your Business’s Operating Capital

Once you know how much operating capital you have, it’s time to figure out how you’re going to use it. The best way to do this is to create a budget.

To do that, you’re going to have to figure out what you have to spend money on. What expenses do you normally have during the course of a year? This is the first place to start when making a plan for your money.

Next, you’ll need to think through the problems you could run into that would increase those expenses. What happens if you don’t sell as much as you were expecting to? Are you planning to launch a new product or service or invest in a new piece of equipment? What happens if some of your supplies get ruined?

The goal of managing your operating capital by budgeting is to make sure you always have the money you need to keep things running day-to-day.

If you’re struggling with this or know you’re about to hit a rough patch and need a little more money that you can move around, there are steps you can take to increase your operating capital:

1. Take out an operating capital loan. Banks often have loans designed to help you get a little more capital during a slow season. As with any loan, be sure you talk it through with your financial advisors to make sure it’s a good move and won’t just drag you farther into debt for no reason.

2. Cut down on your inventory. While having inventory is an asset, having too much inventory means you have cash tied up that you could be using elsewhere. If you need more operating capital, reducing your inventory is often an effective way to get it.

   This is generally a long-term fix since you’ll still probably still have to sell the inventory you do have, but to avoid this problem in the future, you can standardize your products, improve your demand forecasting, or even cut out unnecessary production steps.

3. Get paid faster. Accounts receivable are also an asset, but if you need some more operating capital, you’ll want to free up some cash by reducing them.

   To do this, you simply need to make it more difficult for your customers to delay their payments to you. Send them reminders, decrease the amount of time they have to pay you in the future, and figure out a way to process and send out invoices more quickly.

   Just make sure you’re still working to keep a positive relationship with your customers as you do this because it does you no good to drive them all away in the name of getting cash fast.

Whatever you choose to do to increase your operating capital, don’t stop there. Create systems to help you measure and monitor your business’s operating capital and how it’s furthering or hurting your goals for your company.

Create a team of people who will help you understand these reports and optimize your systems so that you can weather storms and still reach your goals.

Author

Abby McCain

Abby is a writer who is passionate about the power of story. Whether it’s communicating complicated topics in a clear way or helping readers connect with another person or place from the comfort of their couch. Abby attended Oral Roberts University in Tulsa, Oklahoma, where she earned a degree in writing with concentrations in journalism and business.