Operating Capital Definition

Operating Capital Definition

The operating capital definition is the cash used for daily operations in a company. As a result, it is essential to the survival of each and every business. Whether small or large, across industries, and under any other conditions that a business faces, lack of cash is one of the main reasons why a company fails. Due to this fact, it is of key importance that businesses monitor and plan for future cash holdings to assure that the business will have the money needed to continue doing commerce.


NOTE: Want the 25 Ways To Improve Cash Flow? It gives you tips that you can take to manage and improve your company’s cash flow in 24 hours! Get it here!

Download The 25 Ways to Improve Cash Flow


Operating Capital Explanation

Operating capital, explained as the most essential asset in any business, allows a company to stay open. Also known as working capital, it can come from many sources. Operating capital vs working capital is a similar comparison to red vs maroon apples: there is no difference.

The initial operating capital for small business will come from investors. This could come in the form of savings of the owners, friends and family of the owners, banks and the S.B.A., angel investors, or venture capital.

For an existing business, operating capital outlay will come from more providers than for the startup. The same options exist with current owners, friends and family, banks and the S.B.A., and more. Additionally, however, a business can receive operating capital loans from mezzanine financiers, factoring, or becoming a public company and selling stock on the open market.

Operating Capital Formula

Though the operating capital formula is a simple function of subtraction it is actually quite complicated. The difficult part of operating capital requirements is the research associated with finding current asset and current liability amounts. Once these questions are answered the operating capital ratio comes naturally.

Operating Capital = Current Assets – Current Liabilities

Operating Capital Calculation

The operating capital calculation is quite simple.

If:

Current Assets = $1,000,000

Current Liabilities = $250,000

Operating Capital = $1,000,000 – $250,000 = $750,000

Managing your cash flow is vital to a business’s health. If you haven’t been paying attention to your cash flow, access the free 25 Ways to Improve Cash Flow whitepaper to learn how to can stay cash flow positive in tight economies. Click here to access your free guide!

Operating Capital Example

For example, Chris is the CFO of a large company – a series of retail stores which sell plants for home decor. Chris plans the company finances to assure smooth operations. This includes managing company operating capital.

Recently, the company has experienced enormous growth. While this is a great signal that the business model is sound, it can also form a operating capital crisis. Consequently, Chris must move forward carefully to avoid financial ruin for the company.

First, Chris wants to know where the company stands. He then performs this working capital calculation to see where the business is currently:

Current Assets = $1,000,000

Current Liabilities = $250,000

Operating Capital = $1,000,000 – $250,000 = $750,000

Chris knows that $750,000 is not enough money to get the company through this quarter. He also knows that with insufficient working capital the company will have to seek financing from a lender who is less risk averse. So Chris does his research.

The two choices Chris learns are possible are factoring and mezzanine lending. Therefore, Chris will need to do a lot of research to evaluate both options. As he does this research, he is empowered by the importance of his work: the fate of the company rests upon it.

Conclusion

In conclusion, Chris chooses mezzanine lending as the option for the company. With mezzanine lending, he can have a total cost of capital lower than that with factoring. Additionally, mezzanine lenders will offer more money that that in the value of the receivables of the company.

Chris moves forward carefully in order to avoid a mistake. Because his nature as a planner makes this path an easy one, Chris will wait until he is prepared and then make the proper decision.

For more ways to improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

Operating capital

Strategic CFO Lab Member Extra

Access your Cash Flow Tuneup Execution Plan in SCFO Lab. This tool enables you to quantify the cash unlocked in your company.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

Operating capital

, , , , ,

2 Responses to Operating Capital Definition

  1. food choose December 28, 2015 at 12:38 am #

    Hi there to every one, the contents existing at this website are in fact amazing for people experience, well, keep up the nice work fellows.

  2. e-marketing December 16, 2016 at 8:57 pm #

    It can be confusing trying to find the best deals
    with so many to choose from. Every SEO campaign begins with good quality
    keyword research. You can get away with a few technical terms, but don’t overdo it on your content.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.