Operating Capital & Its Importance
Operating capital is the money a business needs to cover daily expenses. Ideally, operating capital comes from business activities that bring in money, such as sales and rentals of business property. But a business needs to find sources of operating capital, even during periods when it is not profitable, to stay afloat.
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Sources of Operating Capital
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Start-up businesses often get operating capital through loans or capital infusions from their owners' personal savings. Stable, mature business get operating capital from ongoing business activities, though even established businesses often use credit or loans during slow times or during periods that require substantial capital outlay. Some businesses such as farms with Community Supported Agriculture programs obtain operating capital by asking customers to prepay for goods or services.
Operating Capital and Profit
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Operating capital is related to profit because a business that earns money is more likely to have funds available than a company that loses money. But a business can have operating capital without earning a profit, for example if it is operating with borrowed money such as an SBA loan. A business can also earn a profit and still be short of operating capital, such as a company that must allocate a substantial portion of its income to repay past debts.
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Importance of Operating Capital
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A business that has sufficient operating capital will be able to pay its vendors, suppliers and employees. In addition, operating capital sometimes enables a business to negotiate advantage arrangements such as low prices as a benefit for prepaying for goods and services.
Dangers of Insufficient Operating Capital
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A business that does not have sufficient operating capital runs the risk of being unable to meet its fundamental financial obligations, such as rent, materials and payroll. A business that is perpetually short of capital will operate with minimal staff and inventory, making it unable to take advantage of opportunities such as unanticipated surges in demand.
Seasonal Businesses and Operating Capital
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Seasonal businesses have an especially tricky predicament with regard to operating capital. A retail business that relies on sales during the holiday season or a farm that harvests produce during a limited season both need to plan ahead and make sure they have sufficient operating capital during critical times of year. Seasonal businesses need to develop ongoing strategies to ensure that they will have enough cash on hand for periods of intensive capital outlay. They also need to generate enough income during busy periods to cover expenses during lean times of the year.
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References
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