Capital is another word for money and working capital is the money available to fund a company’s day-to-day operations – essentially, what you have to work with. To be precise, working capital is the difference between current assets and current liabilities. Current assets refer to the money you have in the bank as well as any assets you can quickly convert to cash if you needed it. Current liabilities are debts that you will repay within the year. So, the left over when you subtract your current liabilities from what you have in the bank is working capital.
What role does working capital play in a business?
Working capital management plays a very important role in the success of any business enterprise. Many companies that are running at loss or struggling financially would be profitable and liquid if were more disposed to the knowledge and practice of efficient working capital management. The working capital management system helps in ensuring that tied down capital that could otherwise be put to productive uses are released. Even though many finance professionals and business experts often ignore the importance of this management. They usually do not go the extra mile in striving for optimum utilization of resources tied to working capital just because they only look at the work involved in carrying out proper working capital management exercise.
What are the benefits of working capital management?
Expansion of investment portfolio:
The funds through working capital management can become your cheap source of finance which will help you in the expansion of existing business or for expanding in new spheres of investment.
The main objectives of engaging in working capital management are increasing profitability. Saving of financial cost results in increasing profitability through adequate working capital management that would have otherwise been incurred but for managing short-term assets and liabilities.
Ensure the availability of sufficient resources:
It helps in better stock management. One of the main components of working capital management is stock management, which helps in the sufficient availability of resources at all times.
Helps in Calculating the cash flow:
Working capital management enables your company’s cash flows to be carefully managed. A professional approach to working capital – in other words, working capital management (WCM) – creates greater financial room for maneuver for companies. It allows in optimizing liquidity, strengthen self-financing capacity, reduce financing costs and improve overall operating margin and profitability.
Helps in assessing your financial performance:
Financial health is of the utmost importance to a small business because it allows them to cover expenses, make investments and continue with their operations. Liquidity management helps small businesses assess their financial performance. Simply put, it helps you determine the amount of cash you have available to make routine payments and meet your obligations, in order to keep your business afloat.
Avoiding liquidity risks:
Liquidity management helps in many ways to avoid liquidity risks. Liquidity risks are situations when a business doesn’t have sufficient funds to meet its current liability. With the right management in place, businesses can implement cash flow forecasting and liquidity buffers to avoid such risks. A good example is a business which is profitable while generating revenue, but it can still fail due to running out of money.
Making the right decisions based on WCM key figures
All key figures for WCM must be considered in the context of the specific company and the sector it operates in. Company-specific drivers and industry-standard characteristics must always be taken into account when interpreting the figures.
One of the key benchmarks in working capital management is the cash-to-cash cycle (C2C cycle). This is a key indicator for evaluating the performance level of individual companies or sectors. The indicator reflects the cash conversion cycle at the company in days between payment to suppliers and in payment by customers, including all days inventories held.
Helps a company avoid overtrading:
One of the fastest ways to business failure is over trading. It leads to mismatching assets and finances. Uncontrolled, out of proportion business expansion are some of the trends signaling overtrading. Sensible cash flow and working capital management are one of the effective ways to avoid overtrading.
The needs for working capital vary from industry to industry, and they can even vary among similar companies. There can be various factors, including differences in collection and payment policies, the timing of asset purchases, the likelihood of a company writing off some of its due accounts, or, capital-raising efforts a company is undertaking. To manage working capital of a business is similar to efficiently managing other resources in it. Other financial indices are considered such as the ratios of turnover, the ratio of the collection, the ratio of key performance. Efficient and state of the art management of working capital will go a long way for effective achievement and set you up for long-term growth tomorrow.
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