There is no specific amount of working capital that is considered “healthy” for all contractors. How much working capital do contractors need? Higher levels of working capital and turnover may help a contractor qualify for bonding on larger contracts. Like lenders, surety companies conduct a financial review in the bond underwriting process. Working capital and NWC turnover are also important metrics for general contractors in public or commercial construction when bonds are required. Learn more: A Contractor's Guide to Financing Options Healthy working capital can often help businesses access higher loan amounts at cheaper rates. Lending institutions - in particular, those issuing traditional financing products, like a bank loan or line of credit - will assess a contractor’s liquidity to determine their creditworthiness. Though largely important for daily operations, working capital can also have an indirect but powerful effect on a contractor’s growth potential. Monitoring working capital helps contractors evaluate liquidity, operational efficiency, and the short-term financial health of the business. If a construction business is an engine, working capital is the fuel that keeps the engine running. Even profitable contractors can become insolvent if current liabilities come due when the company has insufficient liquidity to satisfy them. While profit is important for long-term business growth, working capital is essential for day-to-day operations. Why working capital matters for contractors In 2022, the 10-year average NWC turnover for commercial contractors was 4.6, while highway construction contractors had an average ratio of 6.7. For example, a working capital turnover ratio of 5 means the company is generating $5 in sales for every $1 in working capital employed.Ĭonversely, if a company has a low working capital turnover ratio, they are not efficiently using their working capital to generate sales.Īccording to IBISWorld data, average working capital turnover for contractors typically ranges between 3 and 7, but that figure can vary widely between sectors. NWC is calculated by averaging the working capital balances at the beginning and end of the period.Ī higher working capital turnover rate is better, as it indicates a contractor is more effectively using their working capital to generate revenue. To calculate an accurate turnover ratio, time periods for both revenue and net working capital (NWC) should be consistent. Working capital turnover = Net Revenue ÷ Net Working Capital Ultimately, cash flow management is just one part of working capital management. But because the amount will also be recorded as a short-term liability (accounts payable), working capital would remain unchanged. For example, if a contractor takes a loan and deposits the funds in the bank, this transaction will improve the company’s cash flow. While positive cash flow can lead to an increase in working capital, this is not always the case. Inevitably, some accounts receivable will be uncollectible, and inventory damaged or unsellable. Healthy cash flow is arguably more important for daily operations - after all, subcontractors and vendors don’t accept non-cash assets as payment.Īlthough they are more liquid than long-term assets like equipment, short-term assets still take time to convert into cash. Potential creditors want to see healthy working capital, because a contractor can theoretically sell short-term assets to cover loan payments or bond claims even if they are low on cash. In general, working capital paints a picture of the financial health of the business overall, while cash flow is a better measure of a contractor’s financial health day-to-day - or on a project level. Cash flow is the difference between inflows and outflows of cash, while working capital is the average difference between short-term assets and short-term liabilities. cash flowĬash flow and working capital are closely related, but there are a few key differences between them. While true in theory, some current assets can be difficult for contractors to convert into cash.įor example, while retainage receivable is considered a current account (collectible within one year), it is not uncommon for contractors to wait a year or longer to collect retained funds, depending on the contract and project duration. Of course, the working capital formula contains an inherent assumption that contractors can convert current assets into cash quickly. The formula only looks at “current” assets and liabilities because these are short-term measures. Thus, calculating working capital allows a contractor to determine whether they have access to sufficient cash to pay bills in the near term. Working Capital = Current Assets – Current Liabilities
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