Sunday, December 3

Understanding The Relationship Between Working Capital Management and Working Capital

In working capital management, a company monitors its current assets and liabilities and uses them efficiently to ensure they operate efficiently.

One can use the ratio analysis to determine how efficient their business finances are and know what is working capital management.

How does Working Capital Management work?

Working capital management helps the company maintain adequate cash flows and to suit its working capital needs. It also aids them in fulfilling operating costs or debt obligations in the short term. It is composed of the company’s current liabilities, excluding the current assets.

Working capital management: why is it important?

Knowing what is working capital management, you can keep the net operating cycle, or cash conversion cycle, running smoothly and reducing the time it takes to convert net current assets and liabilities into cash.

The efficient use of resources can enhance a company’s cash flow or working capital needs and earnings quality by enhancing the working capital management process. Working capital management includes both inventory and accounts receivables and payable management.

Any enterprise’s liquidity and profitability are directly influenced by working capital management. Stabilizing operations and securing a company’s future require optimal working capital management. Businesses consider cash, inventories, receivables, and payable to be the main components of working capital.

Current assets are the excess of current liabilities over current assets for a company. A business’s operating budget is how much is available to meet its day-to-day expenses. The availability of working capital determines financial health and operational stability.

The following factors influence working capital:

Business type  

Service-based companies generally require less working capital than manufacturing companies.

Volume of sales

A company’s working capital requirements increase as its turnover increases.

Duration of the cash cycle 

Invoice to cash cycles that are longer require more working capital.

The business seasons  

When a company faces peak and lean sales periods, the company’s working capital requirements fluctuate based on the amount invested in raw materials and inventory.

What happens when you don’t have appropriate working capital management tactics

Working capital refers to ensuring that cash is available daily for operating expenses. Financial liquidity is necessary for companies to comply with their essential obligations. Insufficient liquidity disrupts future growth and survival through disruption of businesses and deterioration of stakeholder relationships.

If working capital is scarce and meeting daily commitments are difficult, inefficiencies creep into the company. When a company finds its daily operations disrupted, achieving its profits and sales targets isn’t easy. Fast is a shortage of funds, and its effects on the business:

– Payments delayed

Having an insufficient cash flow makes it challenging to pay suppliers and utilities on time, which leads to unhappy suppliers. Companies borrow funds at high-interest rates at the last minute, which reduces their profits.

-You could miss out on big business opportunities

Lack of working capital will mean that a company will miss out on increased sales during holiday seasons. The company will be unable to grow if it fails to take advantage of these -opportunities.

-Employee Dissatisfaction

Delays in salary and bonus payments also result in dissatisfied employees due to insufficient working capital. Dissatisfied employees may leave the company, resulting in a massive brain drain, or they may not serve customers as well as possible, causing the brand to suffer.

In the same way that insufficient working capital lowers profits, excessive working capital does. Here are some ways excessive working capital affects profitability.

Idle funds 

In the right investment opportunities, investing excess cash can create incremental earnings that could be lost if companies had large cash reserves. Due to the company not optimizing its capital use, shareholders receive a lower rate of return on their investments.

Excessive inventory 

Unsold inventory could also cause higher working capital. The possibility of mishandling, wasting, or stealing such stocks poses a risk. Inventory overhang also increases storage costs, resulting in unnecessary expenditures and lower company profits.

Read Also: Tips to manage your home loan installments

High Debtors 

Having too many debtors might result in excessive working capital. Past sales with high bad debt risk could be recorded on the balance sheet due to ineffective credit policies, further reducing profits.