• Finance

Operating profit vs. working capital: Why you need to factor both into your business

If you’re planning to freelance full-time, following Jonathan Medows’ advice about “going rogue” is great. You definitely have to start with a business plan. You are, after all, starting a business. It just involves you and only you as the talent capital.

Medows also discusses not going rogue without having sufficient working capital. Having enough working capital to start your full-time freelancing business is crucial. But if you truly want your freelancing business to be successful, you also have to take into account profit planning.

Chicken and egg?

You might argue that calculating both operating profit and working capital is unnecessary. However, they are not the same animal, a mistake many business owners make when calculating working capital.

Once you move into the full-time freelancing business, you will begin to generate revenue. Revenue becomes profit once you’ve subtracted your expenses for a given period of time. As a freelancer, you should calculate this monthly, quarterly, and yearly.

This profit becomes operating profit. Operating profit is the profit earned from your core business services as a freelancer. This doesn’t include any profits you might have earned through business investments. You may not have any of these investments, but operating profit is also your profit before you deduct taxes and interest.

This becomes the account off of which your business “lives.” It is your cash flow. It is also a long-term forecast of your own profitability as a freelancer or business owner.

Assets and liabilities

As your assets and liabilities as a business owner grow, so too will your working capital. Working capital is calculated like this:

Working capital = current assets - current liabilities

Calculating working capital is essential if you have taken out any kind of business loan. It’s also critical for determining accounts receivable and account payable terms. If you pay any business bills within 30 days, but you give your clients 60 days to pay you, you could end up with a working capital deficit.

Accounts receivable and any inventory you keep on hand for resale are current assets. Some freelancers may have no inventory, yet they will have overhead, such as rent and taxes. Overhead is subtracted from operating profit.

Because working capital is determined by assets like accounts receivable and debts and accounts payable, it cannot be used to properly sustain your day-to-day operations.

It can, as Medows noted, be used to start your business, but you must generate cash flow in order to build operating profit. Knowing the difference and building this into your business plan is key to making your freelancing business as successful as possible.