Working capital represents operating liquidity that is available in any business, organization, or government entity. Working capital is a part of the operating capital hence all the assets are a part of working capital. In a simple language, working capital is money received or used to carry out the day to day activities of the company. The major reason to improve working capital is to guarantee that the business runs efficiently and can fulfill all the short term liabilities and its operating costs. If in case current assets are less than the current liability then it is known as a working capital deficiency or negative working capital. Working capital planning includes inventory management, receivable and payable payments, cash management, etc. All the top business keeps working capital management their top priority for their long term financial health. The positive working capital is seen by each investor as it means that there are adequate current assets to fulfill the obligations.
The working capital cycle is also known as a cash conversion cycle is the amount of time it takes to turn net current assets and current liability into cash. The longer this period, the longer a company binds up money without receiving a return on it in its working capital. Companies aim to reduce their period of working capital by accumulating receivables faster or extending payable accounts often.
Minimizing working capital may adversely affect the capacity of the company to realize profitability under certain circumstances. To minimize the total working capital and maximize the cash flow, a positive working capital period balances the incoming and outgoing payments growing industries need the money and will free up cash by shortening the cycle of working capital. It is the easiest option for your company to expand.
- Current Assets: Current assets are owned by the organization, Both tangible and intangible assets can be easily converted into cash within a year or one business cycle whichever is less. Saving accounts, highly liquid marketable securities such as stocks, bonds, and mutual funds, cash, and cash equivalents, inventory are some examples of the current assets. Current assets are resources that can be converted into cash quickly therefore this does not include long-term investment.
- Current Liabilities: Current liabilities are all the debts and expenses the company expects to pay within a year of the business cycle whichever is less. This usually covers the usual operating costs of the company, such as leases, utilities, machinery, and supplies; interest or principal loan payments. Dividends payable and capital leases due within a year and long term debt falls in this category.
Working capital is like the heart of any organization. Any business firm will not be able to survive or prosper without it. It is important to check if the working capital is adequate or not. Adequate working capital is like a nerve center that controls the business. The adequate working capital will raise the credit standing of the b business. It will always be in the position to avail the advantage of any favorable opportunity. During the slump period of the organization demand for the working capital increases. The general morale of the management of the company will increase by the financial soundness of the company. Companies having adequate working capital can easily tide throughout the depression. It is advised that the working capital should not be excessive as it can be disastrous. Here are a few advantages of working capital enhancements.
- Enhanced Business Information: Both vendors and consumers will evolve together if the business adopts a cash exchange process. This will improve the working capital that will help to generate additional market information that will provide useful insights into their operation. Increasing the working capital will allow generating information regarding the insights of their capability and operation.
- Increased Goodwill and Performance: Many large corporations are emerging with the developing environment that is developing strong relations with their vendors and suppliers. During the post-financial crisis companies that align working capital policies to the new economic development environments that can profit and strong profit and supply chains that will help to increase the overall goodwill and efficiency of the organization.
- Heightened Innovation And Perception: Organizations that are funded by adequate working capital will have the ability to invest in various areas like strengthening customer relationships, production efficiency, which will help companies in optimizing and providing the investment forum to introduce a proper working capital policy.
When you understand the different ways to increase the working capital for your companies, it is sure that your company will grow for now and in the future. Here are the most common practices for your business to enhance the working capital.
- Shorter Operating Cycle: As soon as you start spending the money on a project your operating cycle begins. The operating cycle will end as soon as you receive the payment. It is essential to limit the time between the cycle. It would stagger your earnings and damage your cash flow if you wait weeks to deliver your invoices. You may request the payments within 15 – 60 days depending on your industry. Try to minimize the time between project competition and send an invoice. If the cycle is long it can translate to lost income and poor liquidity.
- Credit Checks: If any of your customers have a bad credit score it will have a direct impact on your receivable account. Depending on the scope of the order you will have to run a credit check before signing the deal so that there will be no issues later. You should consider low credit limits for your new customers.
- Collect Outstanding Invoices On Time: Make sure your accounting department monitors all the past due accounts and take the appropriate measure if payments are delayed beyond the given time frame. Uncovering any complications that can keep the customer from making their purchase is critical. Reminders will help speed up the process of collecting invoices. Make sure you don’t wait until the last date; it will make the process slower.
- Limit The Expenses: Make sure there is transparency in the money spent. You will have to examine the budget and do not overspend in any areas of your business. Make sure to strictly follow the budget and restrict any unnecessary expenditure. Examine the expenses of the business trips if any and free some capital. Focus on the functionality of the company. Small amounts spent in the unnecessary expenditure could be used to enhance your working capital.
- Increase Sales Revenue: This will increase your funds and this will increase your revenues. Focus on exceeding the sales and explore the new market channels. Make sure your rates are reasonable depending on your pricing of profits and sales. Profits on revenues may not come in time depending on the business cycles, In this case, don’t forget to work on decreasing your costs.
- Avoid Stockpiling: Every unsold item in your warehouse is a pile of money that cannot be put to use. This decrease in liquidity will make your business less competitive. Focus on maximation of the cash flows. Manage the time of your supplies to arrive exactly when you need them instead of hoarding them in your warehouse. By converting inventory into your cash you will have less capital that is tied up. Another major benefit of avoiding stockpiling is that you will need less space for storage that can cut down some additional costs.
- Lease Your Equipment: Technology advancements are increasing day by day and hence technology gets discarded every few years. These days it is unwise to invest in every piece of equipment. If you want to stay on top of the technological advancements then leasing is the best option for you. Leasing is one of the best options for cash flow management. You can also make use of your assets to improve your working capital by lending out the equipment that you don’t use anymore. You can sell it to the leasing company to get that one-time cash boost. In case you need that equipment later you can lease it back from where you lend it. Many business owners often avoid the unused office space that can be used as a source of revenue. Just like you can lend the equipment you can sell or rent the extra office space that will liquidate the long term assets.
- Leverage Your Account Payables: Many organizations often overlook the importance of a good relationship with their creditors. The major key to this is to maintain a good credit score. You can easily negotiate the extended payment terms if you have a good credit score and a good relationship with your creditors. Though this is not the permanent solution to the financial issues this may help to some extent. While you may try to obtain your receivable accounts as soon as you can, your payable accounts can be postponed as much as possible. You can practice the invoice financing to ensure that you get the cash as per your terms. When you work with the vendors make sure to check for the discounts and negotiable payment terms once you become a loyal customer.
By following these practices you should have a better understanding of the options available when it comes to optimization of your working capital. Your business would have the resources it wants to be competitive by prudent investment, mindful selection, and making the best of the available funds. It is important to be prepared for all the recessionary Crises when companies can face major challenges in funding the business operations. As these incidents arise, more firms decide to slash discretionary and capital budgets and also seek decreases in capability, closures of stores and services, and layoffs. Companies should bear in mind that there are options available for improving working capital that does not require access to credit or another financing.
Management of working capital includes short-term actions, usually “reversible” about the next one-year cycle. Therefore, these decisions are not made on the same basis as decisions on capital expenditure. Instead, they are based on cash flow or sustainability, or both.
- Cash Conversion Cycles: The cash conversion period is the net amount of days from the outlay of cash for raw material to collecting payment from the client, which offers one indicator of cash flow. The interconnectedness of decisions relating to inventories, receivable and payable accounts, and cash is explicit in this metric. Since this figure refers effectively to the time that the cash of the company is caught up in operations and inaccessible for other activities, management typically aims at a low net count.
- Return On Capital: ROC is the most useful measure of profitability. It is determined by dividing relevant income by capital employed. Return On Equity shows this result for the shareholders of the firm. The value of a firm will enhance when the return of capital exceeds the cost of capital that results from capital investment decisions. ROC is a crucial management tool.
- Credit Policy Of The Firm: Another factor impacting the handling of working capital is the firm’s credit policy. It entails the procurement of raw materials and the sale, in cash or on credit, of finished items this will affect the cash conversion cycle.
Best on the studies Here is the basic call to action for the organizations that intend on strengthening the working capital management capabilities.
- Align the management process of working capital with the corporate strategy, centralize the processing of financial transactions, cultivate cross-functional engagement, and provide sufficient support at the executive level.
- Identify the relevant drivers of the importance and uncertainties of working capital management and then use these drivers to build indicators that complement the particular features of the business model of the firm.
- Commit to the ongoing development of working capital management practices by cross-functional collaboration.
- Using supporting technologies to maximize performance and promote associated process changes until the working capital management plan and procedures are in place.
Legalraasta helps its customers achieve an effective place of working capital and promotes cash release to finance additional growth initiatives. Robust structures, streamlined procedures, and strict management of costs and controls resulting in the release of cash are included in a successful working capital management program. By reducing float in various finance processes and developing structures for efficient cash forecasting, we help customers boost their cash operating cycles.
So, what’s in it for you?
- Facilitate extra development with current working capital
- Optimization of cash from the company
- Procurement, payable accounts, inventory, and enhancement of collection processes
- Reducing exposure to debt and managing capital costs
- Highly admirable and information reliability and continuous control establishment.