Working capital is a critical component of any business. Regardless of the sector or size of an enterprise, there should be enough working capital to guarantee good financial health. Making profits is not the true measure of the financial stability of a company. Your commercial entity may be raking in a lot of revenue. But you find that the working capital is not sufficient. Before starting a new business, ask yourself what working capital needs the venture will demand. Research the market and see how other companies operate. But, before we learn more, what is working capital?
Even though no two enterprises are alike, you can clue yourself in on what to expect in terms of your working capital requirements. During the different phases of your business, various financial needs will pop up. These determine how you portion your working capital. Every entrepreneur should learn how to cope with these liabilities and manage them properly to guarantee positive working capital. Here, you will get the basics of what is working capital and management tactics that are useful when running a business.
What Is Working Capital?
The question, what is working capital is one that every aspiring entrepreneur should be able to answer. Working capital is the difference between total current assets and total liabilities. If your company’s assets add up to $200,000 and the liabilities are $90,000, your working capital is $110,000 (200,000-90,000). Every company should strive to have a positive working capital because it means that it can take care of its liabilities.
An enterprise with a negative working capital will have a hard time meeting its long-term objectives. When you can’t afford to stock up your warehouse during peak season, you will miss out on the potential returns. Every CFO should aim to keep a handle on working capital to avoid ending up with a negative on the balance sheet. Start by asking what is working capital, and learning of the various needs of your business.
Who Needs Working Capital the Most
Every enterprise that deals with liabilities needs working capital. These are the funds that companies use for their account receivables, account payables, and inventory, among others. Inventory is one of the biggest uses of working capital. Businesses such as retail shops cannot run without stock.
The presence of working capital ensures that there is a constant supply of goods for consumers. Companies that don’t require inventory to operate have other needs for their working capital. The ability of a company to manage its working capital speaks of its operation stability and profitability.
How much is spent on Working Capital
Next to the question of what is working capital is how much is usually spent. It’s difficult to put a figure on the amount that companies use on their working capital. Some businesses have to maintain higher working capital than others for several reasons. Firstly, each enterprise has its own operating cycle, which influences working capital. The operating cycle refers to the process of creating a product or service, selling it, and receiving payment.
Certain enterprises take a long time to create goods then still have to wait before being paid. Businesses with lengthy operating cycles have to keep a high working capital available to ensure that they can cover liabilities. If a company’s clients don’t always pay on time, then it has to maintain a high working capital as well.
The type of business determines how much operating capital is necessary. Seasonal enterprises, for instance, must have sufficient working capital to supply goods at a particular time of year. Manufacturers have to keep buying raw materials for production to continue, which is why they are some of the biggest beneficiaries of working capital.
5 Ways to Safely Mange Working Capital
1. Think of Everything
After understanding what is working capital, think about how to manage it appropriately. One tactic is to improve your inventory management. Granted that your enterprise can’t operate without stock, but the warehouse doesn’t have to be overflowing.
Buying too much raw material or ready-made goods can put a strain on your cash resources. Involve your sales and marketing team to find out if there are lines of goods that aren’t selling to avoid stocking them.
2. Look Into Your Deals
Cautious discounting can also contribute to boosting your working capital. Your sales team may be doing a great job of bringing in clients through discounts and deals. However, the strategy may also be affecting your working capital.
Giving customers extended credit terms or large discounts can decrease your working capital. Work with your sales department to set limits for discounts and credit terms.
Another management recommendation when trying to learn more about what is working capital, is to negotiate favorable credit terms. One reason some companies end up with negative working capital is that they give their clients better credit terms than they have with their creditors.
You find that your creditors are seeking payment when your debtors haven’t paid yet. Use the company’s buying power to get better deals from your creditors.
4. Reorganize Schedules
Your working capital may be suffering because you give your debtors too much time to pay for services or goods. In such an instance, review your credit terms and evaluate your contracts to see what changes may work out for everyone.
Also, consider the level of credit you extend to customers. Regardless of the buying power of a client or their loyalty, there is something as too much.
5. Check Out Your Company’s Money Process
The collection systems in your company may be lacking in some areas, which may be why payments don’t come in when you need them. When aiming to improve the financial health of your organization, look at the receivables process. Do a proper assessment and see if your invoices are going out in time.
Even a delay of one day can eat into your working capital significantly. Electronic delivery of invoices is advisable to reduce inefficiencies in the receivables system.
To the New Wallet
Some entrepreneurs concentrate too much on beating the competition that they forget about keeping the entity financially healthy. Learning what is working capital is not enough as you have to know how to keep track of it.
An enterprise should always have the resources it requires to settle its short-term liabilities. These vary a great deal, depending on the business. Remember, you can opt for external financing when running low on working capital.
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