Working capital refers to the funds used to meet short-term obligations – payrolls, utilities, leases, and vendors. Adequate working capital is required to meet all of these requirements. For this, you should consider a Business Loan that doesn’t need any collateral as a security.
A company’s assets are ideally used to generate more revenue and increase return. And if it isn’t happening, your company’s growth will stall, and your share price may fall if you’re a publicly traded company.
What is Working Capital Optimisation?
If you are wondering what is working capital and what is its significance? Then you are at the right place.
Working capital is the difference between a company’s current assets and its current liabilities (accounts payable and debts).
Working capital optimisation is essential because it provides numerous benefits, such as improved liquidity, a competitive advantage, uninterrupted production, an improved credit profile, and increased profitability. Working capital optimisation also ensures a higher return on capital and the ability to deal with shocks and peak demand.
What is the State of Your Working Capital Ratio?
Ideally, you want to maintain a healthy working capital ratio. To get the working capital ratio, you need to divide your current assets by your current liabilities. The industry determines the “health” of the ratio, but a healthy ratio can be as low as 1.2 and 1.
Assume your working capital ratio falls from 1.6 to 1.3. Do you have a problem? Is that a good or a bad sign? The answer is usually found in one of these three places:
- Accounts Receivable: Have your sales dropped, or are you having trouble collecting on time? You may need to boost your performance in these areas.
- Inventory: High inventory cost, especially when it is not moving. Storage, insurance, interest, and theft losses can all harm your working capital ratio. Achieving desired inventory levels is beneficial to the health of any business.
- Are All Accounts Paid Yet: Are your vendors giving you a good deal? Is inefficiency costing you money through late payment penalties and interest? Can you work out better payment terms with your vendors?
Your working capital ratio is similar to the “check engine” light on your car’s dashboard. Often, consulting an expert who can help you determine your optimal level of working capital based on the nature of your business is the best option.
How to Accomplish Effective Working Capital Management
There are three primary goals for managing your company’s working capital:
- Ensure that your company has the cash to cover expenses
- Reduce the cost of having to fund working capital
- Increase the return to investors
Methods for Increasing Working Capital
Working capital is critical for MSMEs and small business owners to operate efficiently and effectively. The following are the ways to boost your company’s working capital:
- Pay Vendors on Time
Companies that pay their vendors in a timely manner build stronger relationships and are better positioned to negotiate better deals, payment terms, and discounts.
- Create a Strong Purchase Process
The procurement process must include planning, budgeting, reviewing, closely monitoring unplanned purchases, implementing e-procurement processes, implementing centralised purchase processes or authority metrics in vendor selection, order approvals, and so on.
- Improve Receivables Process
The company must have a good collections system, such as an efficient invoicing system, a customer relations process, a debtor’s ageing system, a payment follow-up system, and a system to discourage bad debts.
- Effectively Manage Accounts Receivable
Improve debt collection, reassess contracts, and credit terms with customers/debtors.
- Effective Inventory Management
Understand optimum stock levels and forecast demands and establish a robust internal communication/dataflow system to avoid miscommunication and incorrect inventory decisions, including overstock or understock issues.
- Assess Working Capital Financing Options
It is prudent to have a bank line of credit (e.g., overdraft, cash credit, etc.) to manage the short-term working capital shortfall. Bill discounting, invoice factoring and other transaction-based innovative financing options are also available.
Now you understand what working capital is. Working capital is the money needed to run day-to-day business operations, improving operational performance and efficiency. Placing an order, producing goods and services, stocking your interests, and selling them to customers are all part of it.
The most important thing here is that the money you need is with you at the right time, in the right amount, and at the right place, known as working capital optimisation. You might want to borrow a loan for a business without security to increase working capital. And you can get such Business Loans from reliable financial institutions; like Poonawalla Fincorp.