Working capital management refers to the efficient administration of all aspects related to a company’s current assets and liabilities. It covers the issues arising in their management and the interrelationship existing between them. Its primary objective is to efficiently manage a company’s assets and liabilities, ensuring it is neither excessive nor inadequate. Assets are components a business can turn into cash, while liabilities are components a company is due to deliver within a period. This article will discuss the different aspects of working capital management.
Importance of Working Capital Management
Working capital management is a management strategy that aims to maintain efficient levels of current assets and liabilities. Assets include cash, debtors, inventory, bills receivable, etc., while liabilities include bank overdrafts, bills payable, outstanding expenses, etc.
Spending more on assets increases a company’s liquidity, reducing profitability and losing opportunity costs. Similarly, spending less on current assets decreases liquidity, increasing the associated risk. Since profitability and liquidity have an inverse correlation, one increases when the other decreases. The primary objective of working capital management is to maintain an adequate balance of both in working capital.
Calculating Working Capital
The mathematical formula to calculate working capital is:
Working Capital = Current Assets – Current Liabilities
Current assets include all assets that may convert into cash within the next twelve months. These include accounts receivable, cash-in-hand, and other highly liquid assets. Available inventory and short-term investment also come under the category of current assets.
Current liabilities include obligations that a company must pay off within the next twelve months. These include accounts payable, debt payments, etc., due during the period. Subtracting current liabilities from current assets will give an idea of the available working capital.
Aspects of Working Capital Management
Let’s look into the aspects of working capital management:
Management of Accounts Receivable
Management of accounts receivable refers to balancing money that a company is due to receive for the products or services it offered to its customers or clients. These accounts are present in the balance sheet under the category of current assets. However, they will gain the status of existing assets only when the company collects money from its recipients. Hence, collecting timely payments becomes essential after a particular period.
The metric gives an estimate of the days the company requires to collect cash from its clients or customers. Proper accounts receivable management is essential to ensure the company does not run out of money to pay its suppliers or vendors. Therefore, it is an integral part of a company’s assets as it helps generate cash influx so that it can settle in the accounts book.
When a company needs immediate cash but cannot wait for the payments to arrive, it can opt for a Business Loan as a practical funding solution. Company owners can increase their cash inflow by borrowing business finance until they receive their accounts receivable. Renowned loan providers also provide working capital loans through their digital lending platforms after successfully verifying details and documents.
Management of Accounts Payable
Proper working capital management is necessary to supervise accounts payable efficiently. These include any money a company is required to pay to others for the products or services it availed. It is another important aspect of efficient capital management. A balance between both accounts receivable and payable is necessary.
Increasing the accounts payable does not change working capital, as it still appears as a liability on the balance sheet. Besides, delaying payment for long will increase the company’s dues by levying late fees, further impacting their credit history. Hence, improper handling of accounts payable or delinquent payments might impact the cash flow, but the practice will affect the buyer-supplier relationship.
Inventory is the main component for any business that converts assets or investments into revenue. These include raw materials that an organisation holds to resell, manufacture, or utilise. Before investing in a company, investors check its inventory turnover ratio. Based on this aspect, they assess a company’s sales strength and efficiency in manufacturing, purchasing, and selling. Companies must sell their inventory to cover expenses, pay bills, and build working capital. Some also use their accounts payable to restock inventory.
Therefore, it is evident that inventory impacts both the company’s assets and liabilities. However, efficient inventory management requires company owners to understand that inventory can be of different types. For instance, businesses involved in manufacturing have their inventory as finished goods, partially finished goods, and raw materials. While finished goods are shown on financial statements under financial accounting, management accounting considers all types of inventory. Hence, efficient investment management is an essential aspect of enhancing working capital management.
How Does a Business Loan Support Working Capital Management?
A working capital loan works similarly to other loan types. A business owner can apply for a Business Loan to cover the required expense and repay it in instalments over a pre-determined loan term. These loans can bridge the financial gap during slow or peak months, accept bulk orders from customers, save money by purchasing raw materials in bulk from suppliers, finance short-term projects, or avoid cash crunches.
Several loan companies provide Business Loans these days online. The application process is 100% digital, not involving any branch visits and paperwork. Reputable NBFCs work much faster than traditional loan providers, which is of great help during urgent money requirements. Many also provide alternative financing options such as bill discounting, invoice discounting, etc. Finding a lender offering ample loan amounts, competitive interest rates, flexible loan terms, and excellent customer service is essential.
Efficient working capital management brings a perfect balance between short and long-term assets and liabilities. Its primary objective is to let a company adeptly handle everyday operations and invest assets fruitfully. For this, having comprehensive knowledge about efficient management is necessary. A Business Loan provides additional support to achieve the goals and smoothly handle operations.