Understanding Working Capital Terms for New Business Owners
As a new business owner, there are a few terms that you really need to understand if you want to manage your money correctly. One of the most important concepts is called working capital. Let’s go through some of the terms related to working capital and see how it affects your startup.
Revenue
Your revenue is the amount of money you take in from sales. It’s also known as income. If you sell $10,000 worth of products in a month, that’s your revenue. This number also includes sales from services, not just physical inventory.
Costs
Calculating costs means adding up the expenses you have every month. This can include things such as rent payments, inventory purchases, taxes and other items you pay for. Costs can include physical things such as equipment purchases/lease payments, and financial obligations such as payroll.
Profits
This is probably going to be one of your favorite numbers. When it’s positive, it means you made more money than you spent in a month. To find out the amount of profits in a month, subtract your costs from your revenue.
For example, let’s say you spend $2,000 to buy inventory. You pay your employees another $2,000 a month. And other operating costs add up to $2,000. Your total costs would be $6,000 for that month. If you sell $10,000 worth of products that month, your profits would be $10,000 – $6,000, or $4,000.
Assets
Current assets are similar to revenue but broader. It includes sales, but also invoices that haven’t been paid yet. Assets also include savings in the bank, cash on hand, inventory and other valuable items.
The expression liquid assets refers to things you can use to pay bills quickly. Inventory can be a liquid asset, but only if you can sell it quickly. The same thing goes for equipment.
Liabilities
This is the amount of financial obligations you have right now. Liabilities include bills you have to pay and normal operating costs for your business that are due. Taxes, rent and loan payments are all included, but only the amount that you have to pay right now, not in several months.
Working Capital
This term is what you get when you subtract your liabilities from your assets. Working capital is also called liquid capital. It means the amount of money or savings you have on hand to deal with emergencies.
The more liquid capital your business has, the easier it is to pay your bills, purchase inventory, invest in business needs and avoid obstacles. It’s more than the profits you take home at the end of the day. Capital is everything for business health, growth and success.
