Starting and running a business is like taking care of a garden. In business, working capital is like the water and nutrients that a garden needs. It’s the lifeblood of any business’s operations which allows it to pay the bills, buy inventory, and keep the business running. In this blog, we’ll explore about Working Capital and its management and the way to handle it effectively.
What Is Working Capital?
Working Capital is the money available to meet the day-to-day expenses of a business and a smooth running of the same. It’s the cash needed to pay the regular vendor bills, purchase materials, and manage the day to day operations. In short, working capital is the difference between the Current Assets and Current Liabilities.
Working capital is calculated by subtracting a company’s Current Liabilities from the Current Assets.
Hence Working Capital = Current Assets – Current Liabilities
Current Assets
Current assets are all the existing short term assets that can be converted into cash within one year. These assets usually consist of:
Cash in bank
Money to be received (Accounts Receivable)
Inventory or Stock
Short-term investments
Current Liabilities
Current liabilities, on the other hand, are all the debts and obligations the business needs to pay within a year which includes:
Bills and invoices to be paid (Accounts Payable)
Short-term loans or lines of credit
Salaries, rent, and other operating expenses payable
Importance of Working Capital
Working capital is as important as a life jacket that is to be worn when swimming in the sea of business. Let’s see its importance from the discussion below:
Liquidity: Having enough working capital ensures to meet all short-term obligations. It’s like having money in the wallet for that unexpected rainy day.
Growth: For expanding the business, adequate working capital is needed to invest in new opportunities. Its like planting new seeds in the garden to help it grow and flourish.
Emergency Funds: Like a financial safety net, working capital can protect any business from unexpected expenses, such as machine breakdowns or sudden adverse market changes etc.
Credibility: Maintaining healthy working capital levels can boost the business’s reputation and make it more attractive to investors and bankers.
From the above, we can see how important Working Capital is for any business. Therefore, there has to be proper management of working capital. Effective working capital management is like maintaining the right balance in a garden, ensuring that the plants have just the right amount of water and nutrients to thrive.
Working Capital Management
Let us see the process of Working Capital Management through the following steps:
Cash Flow Analysis
Working Capital can be managed effectively by knowing the movement of money flows in and out of any business. It’s like understanding the seasons in a garden. Analysing the cash flow statements can show when money comes in (e.g., sales) and when it goes out (e.g., expenses). This information will help to plan for lean times and ensure to have sufficient working capital to meet the expenses.
Accounts Receivable Management
Accounts Receivable, or the money to be received by the business from its customers are like the fruits of the efforts put in maintaining the garden. The business should ensure to collect these payments promptly by issuing invoices regularly and also by offering incentives for early payments. Timely collections of money would keep the cash flowing and give a boost to its working capital.
Inventory Management
Inventory of materials can be compared to a garden’s requirement of seeds and tools. Having an overstock of such things can go waste or make the business run out of critical supplies of materials. The business should keep a close eye on its inventory levels, optimize its ordering procedures, and utilize Just-In-Time (JIT) concept to manage its inventory to maintain a balanced working capital.
Accounts Payable
Accounts Payable or the bills to be paid, are like the water and fertilizer a garden needs. The business has to make sure to pay all its bills on time to maintain good relationships with its suppliers. This will ensure that the business is not using its working capital unnecessarily.
Monitoring of Cash
Cash reserves are like the water stored in the garden. Cash may be needed for unforeseen emergencies or opportunities. The business has to ensure to maintain some cash cushion or may take a short loan to cover any unforeseen expenses. Having this buffer can prevent the business from dipping too deeply into its working capital.
Debt Management
Debt management is like selecting the right soil for the garden. Some debt can be useful but too much of it can weigh the business down. Business loans and other credit has to be carefully analysed. If the debt levels are too high, the business can consider in consolidating or refinancing it to reduce interest costs and free up the working capital.
Review of Working Capital Ratio
Checking working capital ratio is like checking the health of the plants in the garden. It can be calculated by dividing the Current Assets by the Current Liabilities. A ratio above 1 denotes a healthy working capital, but if it falls below 1, necessary action has to be taken to enhance the working capital.
Cut Unnecessary Costs
The business should identify and cut unnecessary costs from its operations. Just as trimming down any overgrown branches in a garden, some expenses can be reduced that don’t contribute to business’s growth. The operations should be streamlined and the areas where the overhead expenses can be reduced to preserve working capital has to be identified.
Seasonal Variations
Just as specific crops are planted during certain seasons in a garden, the business needs to plan for seasonal variations in the business. It should ensure to adapt its working capital management strategy to these fluctuations.
Market Trends
Understanding market trends is like monitoring the weather for a garden. The business needs to stay updated on the developments happening in the market and industry. Being proactive and adapting to the market conditions can help any business to stay ahead of the competition and maintain its working capital.
To summarize, Working Capital management must not be looked as a complex exercise. It has to be seen as tending to a garden, making sure that it has just the right amount of water and nutrients to thrive.
By understanding the cash flows, optimizing accounts receivable and payable, and monitoring the cash reserves, business finances can be controlled efficiently. One should avoid common errors like excessive debt or ignoring the market changes.
Reviewing of the working capital ratio regularly will ensure that the business is on the right path. Effective working capital management is an efficient tool to help a business grow and flourish, just like a well-tended garden.
SHREYASS FINANCE, has been assisting businesses in availing Working Capital Loan, WCDL and other customized loan options in MSME sector throughout India.