Accounting Basic for Startups

“Accounting Basic for Startups”, this article will throw light on the calculation and interpretation of key financial ratios for evaluating the performance of concern. 

Working Capital Management is a process to check whether your current assets or easy convertible into liquid cash is enough to cover your current liabilities or expenses. Comfortable Working capital suggests financial viability and sustainability, as it indicates that the Startup has sufficient cash in order to meet its short-term debt obligations and operating expenses. 

Before discussing Working Capital Management, let’s get versed with some basic terms and concept of Working Capital. Working Capital measures both company’s efficiency and its short term financial health.

The working capital ratio is calculated as below - 

                  Working Capital = Current Assets + Current Liabilities 

Ingredients of Working Capital:

Current Assets - A balance sheet item which represents liquid cash and cash equivalents, accounts receivables, marketable securities, inventory, prepaid expenses and all other assets that could be converted to cash easily. 

Current liabilities – A company’s debts or obligations that are due in the near future, and includes short term debts, accounts payable, accrued liabilities and other debts. 

Value and Time Concept in Working Capital 

VALUE: From the value point of view, Working Capital can be segregated into Gross Working Capital or Net Working Capital. 

Gross Working Capital - It refers to the firm’s investment in current assets.

Net Working Capital - It refers to the difference between current assets and current liabilities A positive working capital means that the company is able to pay off its short term liabilities, whereas a negative working capital suggests that the company currently is unable to meet its short term liabilities. 

TIME: From the point of view of time, it is referred to as permanent or temporary. 

Permanent - Permanent working capital refers to the minimum level of investment in the current assets by the business at all times to carry out the minimum level of activities. 

Temporary - Temporary working capital is also known as variable working capital refers to that part of total working capital, which is required by a business over and above permanent working capital. 

Importance – Effective Working Capital Management Founder of a Startup is accountable to determine and ensure the requirements of working capital carefully in such a way that the amount of working capital available with him is neither too large nor too small for its requirement. An as a large amount of it would mean that the Startup has ideal funds. 

Since the funds have a cost, they have to pay interest on such funds. On the other hand, if there is inadequate working capital, then the business might run into the risk of insolvency, and the continued paucity of adequate working capital can seriously challenge the financial viability and sustainability of the business. Optimum Working Capital There is no standard rule for an Optimum Working Capital. The working capital requirements vary from industry to industry. 

Traditionally, the Current Ratio (Current Assets: Current Liabilities) of 1.5 to 2 is considered to be a comfortable liquidity position. However, it should be remembered that optimum working capital can be determined only with reference to particular circumstances. Thus, for an example: If a firm has sundry debtors, as good as liquid cash then, in that scenario even a current ratio above 1 would be comfortable for the business. 

DETERMINANTS OF WORKING CAPITAL Cash - Identification of cash balance for meeting day to day business expenses. 

Inventory - identifies the level of inventory needed for uninterrupted production, also which reduces the investment in raw materials. 

Debtors – It identifies the appropriate credit policy, i.e., credit terms which will attract customers. Small or Large Business - It is the determinant of working capital that it is affected by the nature of business. 

Small or Large demand – The urgency of the demand for the product in the market also determines the level of working capital required for a business. 

Technology and manufacturing policy – for instance, in some businesses the demand for goods is seasonal, in that case, a business may follow a policy for steady production throughout over the whole year or instead may choose a policy of production only during the demand season. Sign up for Newsletters Check out our popular newsletters and subscribe 

Price Level changes –businesses using a raw material having price volatility would require a higher level of working capital vis-à-vis a price-stable input raw material. 

Effect of external business environmental factors - There are external business environmental factors which affect the need for working capital like fiscal policy, monetary policy and bank policies and facilities. 

The business cycle – every business considering the cycle of business it is in, would have a different level of working capital requirements. 

To Conclude The actual sustainability of the business is established when it is able to pay off its day to day expenses from day to day revenue. 
Normally, businesses make a mistake of paying day to day expense with infrastructure resources in the absence of proper working capital requirement analysis.