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1.5 Determine Working Capital Requirements
Entrepreneur Quebec-based Innov International Inc. had to be flexible in raising the funds needed for growth. Let's take a look at how you can figure out your working capital requirements. How Working Capital Needs Are DeterminedTo figure out how much you'll need to fund business growth, consider the four key areas in the financial needs equation:
working capital + fixed assets + marketing costs + financial cushion
Let's look at the first of these four important components — your working capital requirements. Working capital is the amount you need to pay for the day-to-day operating costs of your business. It consists of:
To determine working capital requirements for your investment proposal,
you build projections for these items (accounts receivable, inventories,
accounts payable). Then you compare your actual amounts to the figures
you've forecasted. The increase in current liabilities (e.g. accounts
payable) is then subtracted from the increase in current assets (e.g.
accounts receivable and inventories). The difference — or change in
working capital — represents the amount of money you'll need. change in working capital =
Besides accounts receivable, accounts payable, and inventory, there are other working capital accounts that may enter into the equation. These include sources of funds that reduce the need for working capital (bank and other loans) and uses of funds that require working capital (marketable securities, prepaid expenses, other assets, supplies and accruals). In this case, the equation becomes:
change in working capital =
An Example: New Tech's Working Capital
Based on its balance sheet projections and statement of changes in financial position, New Tech identified the following increases in accounts receivable, inventory, accounts payable, and other working capital accounts. The company will need $200,000 to fund the changes it is predicting.
For a closer look at the information that supports this calculation, see the example in Calculating Changes in Working Capital. Check Your Understanding
Innov International's Working Capital NeedsInnov International was looking for financing of around $4 million to launch the new office products company. Having assessed that this amount would be very difficult to raise at the start-up stage, management and its advisors revised their plans and decided to rent a building rather than buy one. Innov International then decided to seek a little more than $1 million in financing. This included operational costs of about $600,000 and capital costs of some $400,000. This financing was allotted for the start-up of operations, to buy all necessary manufacturing equipment and a delivery truck, and to renovate a rented manufacturing facility. |
Updated: 2005/07/12 |
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