Month: January 2021

According to statistics, 82% of business failures are due to insufficient cash flow and a lack of net working capital (NWC).

Perhaps more alarmingly, global reports show that more than 90% of businesses may not have a transparent view of their cash flow.

If you are looking to optimize your cash flow, one of the financial metrics that you should be looking at is net working capital. By calculating NWC, you will get a bird’s eye view into your business’s short-term ability to meet its financial obligations.

What’s more, once you know how to calculate net working capital, you may be able to take steps to improve this metric. With that, you will improve the health of your business and be able to attract capital investment if you so wish.

Ready to learn more about net working capital and what it can do for your business? Read on.

What is Net Working Capital?

The first question is, what is net working capital?

NWC is the difference between a business’s total current assets, and its total current liabilities. NWC stands as a measure of a business’s liquidity, its operational efficiency, and its ability to meet current financial obligations.

To understand why this is, let’s take a look at what current assets and liabilities consist of.

Definition of Current Assets

Current assets are the assets listed on a balance sheet that are considered to be short term assets which can be converted into cash within a year. Cash itself is also a current asset. Here are some common examples of other current assets:

• Cash equivalents (money market funds, treasury bills, commercial paper, and short-term government bonds)
• Marketable securities
• Accounts receivable
• Inventory or stock
• Prepaid expenses

If a business holds properties that are expected to sell within 12 months’ time, these also constitute current assets.

Definition of Current Liabilities

Current liabilities are comprised of all liabilities found on the balance sheet that are due within the year. These include:

• Accounts payable
• Accrued expenses
• Taxes payable (including payroll and sales tax)
• Current portion of long-term debt
• Bank overdraft
• Current maturities of long-term debt
• Credit card debt
• Dividends payable
• Wages
• Customer deposits

Anything else you owe which is due to be paid within the year is typically considered a current liability.

How to Calculate Net Working Capital

The net working capital formula is simple. As mentioned above, NWC equals current assets minus current liabilities.

Current Assets – Current Liabilities = Net Working Capital (NWC)

However, depending on the application, you may want to tweak which current assets and liabilities are included in the formula to arrive at a working capital figure that reflects the data you need.

The broadest way to calculate working capital is by subtracting all current liabilities from all current assets. However, to refine your result, you may wish to exclude certain current assets or liabilities.

For example, one common variation of the formula for NWC is:

Accounts Receivable + Inventory – Accounts Payable = Net Working Capital

This formula will yield a better indication of the relationship between a business’s payable expenses and its receivable income and available inventory.

The exact method for how to calculate net working capital will often depend on what an analyst wishes to reveal or pinpoint through the calculation.

How to Calculate Net Working Capital Ratio

Another helpful metric you can calculate is the NWC ratio. This is the percentage of a company’s current assets to its short-term liabilities.

To calculate it, simply divide your business’s current assets by its current liabilities.

Ratios of between 1.2 – 2 are considered optimal. Lower than this and the ratio will indicate illiquidity and danger of insolvency. Higher ratios than 2 show that current assets are not being leveraged to further company growth.

Why is NWC Important?

Being able to analyze the NWC of your business is invaluable, as this will give you an insight into its cash flow and its ability to weather the year’s financial demands.

What’s more, having a clear idea of your business’s NWC will also indicate whether you are in a position to increase capital expenditure. If your net working capital ratio is above 2, then you may want to look into profitable avenues for capital expenditure so that your current assets can begin to stimulate growth rather than stagnate.

According to research, reducing excess working capital could pay for a 55% increase in capital expenditure in certain organization—something which could significantly drive expansion for your business if implemented well.

On the other hand, if your NWC and its ratio are low, or even negative—you will need to take into action some urgent measures to improve liquidity before you think of increasing capital expenditure.

How to Improve Your Net Working Capital

If your NWC is low, this shows that your business is in a precarious financial situation. However, there are several things you can do to improve this metric.

Refinance Short-Term Debt

If short-term debt is making your net working capital formula liability heavy, you can look at refinancing. Refinancing short-term debt into long-term debt will shift the numbers and improve your available net working capital.

Secure a Working Capital Loan

Another way to resuscitate your business’s net working capital is to take out a working capital loan.

If you are able to secure this type of loan with long terms, you will be able to boost your business’s current assets in the form of cash, while not adding substantially to its current liabilities.

Sell Long-Term Assets for Cash

If your business is sitting on unproductive long-term assets, selling these will instantly shift your business’s net working capital ratio to your favor.

According to the Small Business Association, over-investing in fixed assets is one of the top causes of business bankruptcies, so take a careful look at what your business owns and decide if it’s a profitable asset or whether it should be sold.

Boost Inventory Turnover

Another strategy for improving net working capital is to boost inventory turnover. This is not always as simple as selling assets, refinancing, or securing funding. However, the gains can be substantial, as inventory will realize an appreciation when sold.

For example, if you have $5,000 worth of stock on hand, once this is sold, it should bring in a cash value of up to $10,000.

Are You Struggling with Cash Flow? Consider Applying for Accounts Receivable Financing

Depending on your business, sometimes it’s not possible to fix cash flow and increase net working capital numbers overnight.

However, if you are struggling with cash flow, you can also look at accounts receivable funding. The way this works is simple. If you have accounts receivable that you would like to turn into cash, you can sell your unpaid invoices at a discount.

To find out more, you can read about accounts receivable financing here or get started by filling out our free 90-second online application today. If you have any questions, please contact us.

Congratulations! Your business is off the ground, and you’ve hired your first W-2 employees, now it’s time to learn what a Form 940 is.

As you prepare to run payroll, you’ll notice that there are multiple forms to complete, taxes to pay, and complexities to navigate. Maintaining a team takes more work than simply paying wages every two weeks.

One of the documents you’ll need to understand is IRS Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return.

Not sure what this is or how to complete it? Read on for the details you need to know.

What is Form 940?

In short, Form 940 is the place where you’ll report your FUTA tax. Most employers in the United States will need to file it with the IRS once per year.

Here, you’ll report the wages your company paid to all W-2 employees, including both full-time and part-time workers. The FUTA tax only applies to the first $7,000 you paid each employee that year. This amount is known as the federal or FUTA wage base.

Using the standard FUTA tax rate of 6%, you’ll then calculate how much your business owes to the IRS. Regardless of how much they make, you’re only liable for $420 FUTA tax maximum, per employee, per year (6% of $7,000).

Form 940 vs Form 941

At first glance, Federal Form 940 might look similar to another tax document, Form 941: Employer’s Quarterly Federal Tax Return.

While there are some areas of overlap between the two, there are also important differences.

Form 941 is completed and filed every quarter and includes a place to report your federal income tax withholding and Federal Insurance (FICA) taxes. Those FICA taxes are considered shared taxes, with payment, split 50/50 between the employer and employee.

If you manage a very small business with an annual FICA and withholding tax liability of less than $1,000, you’ll file IRS Form 944 once per year, instead.

On the other hand, you’ll file Form 940 once annually, and it only reports your FUTA taxes. As the employer, you’re responsible for paying 100% of all FUTA taxes.

Do I Need to File One?

If you’re an employer in the U.S., you’re usually required to pay into Federal Unemployment benefits for your employees.

If an employee is terminated from your workforce for issues that are not performance-related, these funds enable them to collect unemployment compensation.

Not sure if you’re required to complete the form? Ask yourself if the following conditions apply:

• You’ve paid at least $1,500 in wages to any W-2 employee at your company
• You’ve employed at least one W-2 employee (full-time or part-time) for a minimum of 20 weeks out of the past year.

If you can answer these statements affirmatively, you’re required to complete Form 940. However, the IRS does make two exceptions. The following entities are not required to pay FUTA taxes:

• Non-profit or religious organizations and any other 501(c)(3) accredited firm
• Businesses that work exclusively with independent contractors (not W-2 employees)

A tax professional can help clear up any confusion on your requirements surrounding Form 940. If you’re unsure at all about your tax obligations, it’s best to double-check.

A Step-by-Step Guide to Filling Out Form 940

You’ve determined that you need to file this document, but how do you do it? Let’s take a look at the steps to follow when you’re ready to tackle your first Form 940.

Step 1: Gather Important Data

Before you begin filling out boxes and pulling out your calculator, there are a few key pieces of data to assemble. These include:

• The current FUTA tax rate (normally 6%)
• The number of employees you’ve had this year
• Each employee’s total salary
• The amount you paid in state unemployment (SUTA) tax that year

Step 2: Calculate How Much FUTA Tax You Owe

Thankfully, the calculation used to determine your FUTA tax obligation is relatively straightforward. To find it, you’ll multiply your total number of employees by the maximum taxable amount ($7,000). Then, you’ll multiply that figure by the current FUTA tax rate.

For instance, say your small business employed 15 people over the past year and they each made $25,000. Your FUTA tax calculation would look like this:

• (15 x $7,000) x 6% = $6,300

This means you’re responsible for paying $6,300 in FUTA tax. However, most small business owners make quarterly payments toward this amount throughout the year to offset year-end costs. If you did so, just subtract what you’ve already paid from the total amount that you owe.

Step 3: Calculating and Crediting SUTA Tax

In addition to FUTA taxes, most small business owners are also responsible for paying state unemployment (SUTA) tax.

While these costs can feel overwhelming, the good news is that you can normally claim SUTA payments as credits on your FUTA tax obligation.

How does it work?

You’ll simply subtract the SUTA tax rate for your state from the FUTA tax rate and pay the remainder. To determine your SUTA rate, go to your state’s Department of Labor (DOL) page.

Say your SUTA rate is 4%. If the FUTA rate is 6%, and you’ve already made your required 4% payment to the state, you’ll only have to pay 2%. The IRS normally allows most employers to claim up to 5.4% in SUTA credits.

Let’s use the previous example to see how this calculation works in real life.

• 15 employees x $7,000 (maximum FUTA threshold) = $105,000

Say your state has a SUTA rate of 5.4% (the maximum). You’ve already paid this, so your federal tax obligation is only 0.6%. Now, instead of paying $6,300 in FUTA taxes, you only owe $630. That’s much better!

Submitting Your Form 940 to the IRS

Most business owners are required to submit Form 940 by January 31. The only exception? If you owe more than $500 in FUTA tax per quarter, you’ll need to file the form quarterly.

When your form is completed and ready to submit, you can get it to the IRS in a few ways. Your options include:

• E-filing and paying online
• Mailing in hard copies of your documents and payment
• Partnering with an accountant who can file on your behalf

Form 940: Simplified and Explained

It’s no secret that your tax obligations as a business owner can be complex and confusing.

This is especially the case when you’re navigating Form 940 for the first time. This article can help you complete this documentation and mark it off your to-do list for the rest of the year!

Need a little more assistance as you navigate the journey of business ownership?

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