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Why Working Capital is important to your business

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Why Working Capital is important to your business

April 6, 2018 | ignite | blog

Many at times, businesses find themselves in a fix where they cannot meet their short term financial obligations due to delayed payments or slow-moving stock.

Working capital is defined as the amount of capital needed to carry on a business – regardless of size. By calculating your working capital, you able to understand something much deeper: your liquidity. With this measurement, you can make an accurate assumption on the efficiency and financial stability of your company.

So why is working capital important to any business: Besides the fact that understanding your working capital needs can provide you with great insight on your company’s financial health, strong working capital management can enable you to propel your business forward.

When you maintain a certain level of working capital, you can not only successfully pay off your short-term expenses and debts – which in most cases are paid in cash, but you can also pick and choose the right money to set aside for investing in your future.

Some of the top reasons why you might need working capital to keep your business moving are as follows:

  1. Cashflow assistance: Cash is king. You need enough money to fund normal day-to-day operations, regardless of how well the business is doing.
  2. Purchasing new stock: A business needs the right amount of stock in the right place at the right time or help to buy larger amounts of stock at discounted prices on better terms.
  3. Paying suppliers for better terms: Making upfront payments to suppliers may generally improve business relationships and provide the advantage to negotiate better terms. Great business relationships with partners, suppliers and contractors should never be underestimated.

Controlling the components of working capital is key to managing your working capital requirements for your business. Having too little WC (working capital) impairs a company’s ability to meet its financial obligations. It is hard to pay expenses or debts when they fall due.

WC can be adjusted by increasing or decreasing its two components: Current Assets (CA) and Current Liabilities(CL). Increasing CA or decreasing CL increases WC. Management can enact several policies to improve the WC situation of a business as follows:

  • Cash Management: Identify the cash balance that allows the business to meet day to day expenses, but reduces the cash holding costs. Keep this at optimal levels.
  • Inventory Management: Identify the level of inventory which allows the uninterrupted production but reduces the investment in raw materials-and minimizes reordering costs-and hence increases cash flow.
  • Debtors management: Identify the appropriate credit policy, such as credit terms, that will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence return on capital.
  • Financing management: Identify the appropriate source of financing for your working capital needs. Some of the financial products in the market to solve this problem are invoice financing, trade finance and supply chain finance.

By adjusting these four primary influencers on Current Assets and Current Liabilities, management can change WC to a desirable level.

Cash is king and much effort should go to maintaining a business’s working capital needs at optimal levels for smooth business operations.

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