Working capital is a very important metric in measuring and/or assessing the long-term financial health of a business or enterprise no matter the company’s size or industry sectors.
For the purpose of clarity, Let’s analyze the definition of Working capital. Working capital, which can also be referred to as net working capital (NWC) or operation liquid, is the financial metrics that differentiates a company’s current assets, such as cash, accounts receivable (customers unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable.
Therefore, this further explains that the level of working capital available to an organization or business can be measured by comparing its current assets against current liabilities.
Working capital is an important key factor for any business to pay its trade creditors for its day-to-day trading operations. Businesses which are still in growth often suffer from a lack of working capital due to long payment terms. In general, working capital serves as a metric to determine how a company is efficiently operating and how financially stable it is in the short-term. The most important positions for effective working capital management are inventory, accounts receivable, and accounts payable.
The needs for working capital varies from business to business, and they can even vary among similar businesses or enterprises. This is as a result of several factors, including differences in collection and payment policies, asset purchases, a company writing off some of its past-due accounts receivable, and in some instances, capital-raising efforts a business is undertaking.
Effectively managing working capital should be one of the top priorities of an entrepreneur, as it serves as a means for assessing the long-term financial health of a business or enterprise and ensures that the business always maintains adequate cash flow to meet its commitments and obligations. Efficient working capital management helps to not only cover financial obligations but to also maintain smooth operations and can also help to improve the company’s earnings and profitability.
Lack of effective management of the working capital could cause the business to suffer from cash flow problems that could possibly affect the ability to produce, grow, improve processes or even operate their business or enterprise which could in some case result in legal troubles, liquidation of assets, and potential bankruptcy.
Generally, entrepreneurs aim to achieve a high level of working capital. A high level of working capital indicates that a business is being well-managed with a greater potential to expand. There are also several benefits to having a high level of working capital including improved liquidity, profit increase and operational efficiency.
Let’s Look at Some of the Benefits of Positive Working Capital.
To Obtain a consistent high level of working capital, entrepreneurs and business owners need to ensure that adequate cash levels are available for any potential opportunities and/or unanticipated scenarios. It also serves as means of giving an entrepreneur more flexibility over how they run their operations which enables them to fulfill custom orders, expand and invest in new products at a faster rate.
High level of working capital is achieved when all areas of the business including account payable and receivable are operating effectively. It is important to ensure that suppliers are paid in terms of agreement as this will result in an increase in the income (cash) and profit.
To avoid future hindrances in business operations, an entrepreneur needs to make optimum use of the working capital.
Having analyzed the importance of consistently maintaining a high level of working capital, it is also very important to understand that there is a level considered as ‘too high’.
Having an extremely high level of working capital indicates that there is more funds (money) in the business than is needed– that cash is not being invested correctly or the entrepreneur is neglecting the growth and expansion of the business in favor of high liquidity.
Tips for Effectively Managing Working Capital
1. Managing procurement and inventory is an important factor in terms of working capital. This simply means avoiding excessive stocks and insufficient stocks at the same time. Therefore, the key challenge is for entrepreneurs to establish optimum stock level. If stock levels are unknown, then it is difficult to manage the optimum level and the business risks experiencing a loss in sales as a result of a shortfall in materials. Periodic inventory checks are necessary in monitoring levels of different types of stock.
2. Enforcing payment discipline should be a key part of your payables process. Entrepreneurs need to learn the habit of paying vendors in time. Businesses that pay on time develop better relationships with their suppliers and are in a stronger position to negotiate better deals, payment terms and discounts.
3. One important aspect of working capital is to send out invoices as soon as possible. This simply means maintaining an accurate debtor’s ledger to ensure that you are on top of debtor collection dates and can send timely reminders to your customers regarding payment. This keeps an Entrepreneur on track with the happenings in the business.
4. The best way to ensure you have working capital is to make sure money is coming in on time. It is necessary to effectively manage debtors so as to reduce bad debts.
5. Prioritizing working capital allows businesses to make strategic investment decisions, which drives operational performance and efficiencies.
Conversely, not having enough operating liquidity because assets are tied up in inventory or unpaid invoices can have a huge effect on cash flow.
Therefore, it is important that entrepreneurs make informed financing decisions.
In conclusion, the important key is to consistently maintain positive working capital, while avoiding an extreme high level that leads to waste and inefficiency.
Therefore, it is wise and very important for an entrepreneur or business owner to look up at some current working capital techniques to see where mistakes and gains have been made before undertaking any strategic techniques which might hurt the business.
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