Working capital is the sum of current assets minus the current liabilities. Keeping an eye on the capital that is used in its day-to-day trading operations called working capital is essential. The overall process is under the management of working capital. Having details about the current cash and current liabilities help a company to know if the company has enough cash flow to cover the short-term debts and expenses. When a company keeps the information about working capital in hand then the company can plan accordingly. Whether the company can make new investments to grow the business. Find sources for the day-to-day expenses depends on the amount of capital that they have.
Working capital is the key indicator of the state of your company. Hence management of working capital is very important for a company to operate smoothly without any problems. When you know what you have in hand you can predict whether you need to manage more capital. The capital that you have is enough and can be invested for something new. Therefore nowadays business people are giving importance to working capital management. Keeping a separate department to look after the working capital.
What happens when you have plenty of working capital?
When there is sufficient working capital there is more flexibility in the company. That enables you to fulfill your customer's orders and also expand your business at the same time. Investments can be made in new products and services. You do not have to worry much about any financial problems shortly because you have enough capital in hand.
What happens when there is scarce working capital?
One major problem of less working capital is the inability to pay your suppliers in time. This problem is likely to raise a question in your trust with the supplier which later might result in the cancellation of the contract with your company. In the worst-case scenario, a company might reach the state of bankruptcy or liquidation. However, sometimes there is a lack of working capital because you invested in a new stock which would give you good returns. In such cases, there is no need to worry much but one always needs to be careful about not buying excess stock and increasing customer debt because it can have significant consequences for your company later.
When you have too little working that is a problem for you and when you also have excess capital you need to utilize it somewhere to either grow or expand your company.
So how much working capital does a business require?
There is not any hard and fast rule about having a certain amount of working capital because every business is unique from one another. Some assumptions can be made about the kind of business that you are doing. If you have a retail company, such companies need higher working capital because they need to purchase extra stock and keep it until it is sold. At times it might take too long to sell the stock so such a company would need higher capital. It is not that hard for bigger businesses to raise finances quickly, but while operating small businesses, one has to always have some extra work.
How to manage working capital effectively?
Management of inventory and procurement
In this, prudent inventory management plays an important role. Excessive stocks can place a heavy burden on the cash resources of the business. At the same time, insufficient stocks can also result in lost sales and degrade customer relations. You should keep optimum stocks and avoid driving up costs for physical storage and insurance as well as wasting stock if it's sensitive to time.
Pay your vendors or suppliers in time
While doing business one must always stay up to their contract and make payments in time. Enforcing payment discipline is a crucial part of the paying process. Not being able to pay your suppliers on time might create issues for your business in the long run. Also, increase your payables and liabilities which create a negative impact on capital. Therefore one has to be on time to pay their suppliers.
Shorten receivables process
There might have been deals where you provided a service or sold a product but didn’t collect receivables on time. Having a good collection system minimizes the problems and helps to collect the receivables. The use of accounts receivable technology to deliver invoices electronically helps in speeding up the billing and collection.
Manage your debtors
To compensate at times during lacking, the only people that can help you are debtors. So, make sure that money is coming on time. Reassess your contracts and credit terms to make sure that you aren’t giving your debtors too big a window. Your company’s cash flow might be affected negatively and you need to reduce bad debts. By implementing more rigorous credit checks and ensure that there are effective credit control procedures to chase late-paying customers.
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