Understanding Working Capital Management for Small Business Owners in 2022
Working capital management is one of the best indicators regarding a company’s health. Sound working capital management is a sign of a good business, but with the business’ growth and soaring sales, cash flow and the working capital balance will be affected.
Growing business causes increased expenses and a lack of working capital when cash is needed the most.
Working capital, in simple words, is the difference between a firm’s available assets and its liabilities. This includes cash, unpaid invoices, current accounts payables, existing inventory, and liabilities. But we need to understand how these different elements come together to form the basis of working capital management.
Key Components Of Working Capital Management
Working capital management typically consists of three key components that determine the financial health of your business.
1 – Accounts Receivable
Accounts Receivable is all of the money currently owed to your company for services or goods you’ve already delivered and for which you are expecting payment. Your accounts receivables also include any outstanding invoices you’ve sent to clients or customers that they’ve agreed to pay but haven’t done yet.
The most important thing about your accounts receivables is that you can know whether or not you have sufficient cash flow to meet your debt obligations. In the event of any gaps in cash flow, these invoices can be used as collateral for borrowing money. When you are aware that you have incoming cash flow on the books, it can be a deciding factor when applying for funding.
2. Accounts Payable
The opposite of accounts receivable, the accounts payable is a short-term debt and a liability on a balance sheet where a business owes money to its vendors/suppliers who have provided the business with goods or services on credit.
Sometimes, companies delay payments as long as they can to maximise available positive cash flow.
Payment terms of net-30, net-60 and longer are commonplace among businesses.
Large corporations may benefit from net terms in the short run. They can, however, have a cascading effect on small and medium-sized businesses (SMBs) whose cash flow is hampered as a result of the tardy payment.
3. Assets and Inventory
The inventory that your company has on hand is viewed as a beneficial asset. This is based on the assumption that all of your merchandise will be sold and converted to capital. The way you handle your company’s inventory might be a good indicator of your company’s overall operational efficiency. It’s critical that your company has enough inventory on hand to fulfil orders, but not so much that your inventory blocks an excessive amount of working capital.
How well you manage your working capital is determined by how well (or poorly) your business handles these three critical components. Now that you’ve learned what working capital management is, you should realise why it’s so crucial.
How Is Working Capital Calculated?
Working capital is computed by subtracting current liabilities from current assets on the balance sheet of an enterprise. Cash, accounts receivable, and inventory are examples of current assets. Accounts payable, taxes, wages, and interest fall under current liabilities.
You can use this formula to determine the availability of short-term liquid assets after short-term liabilities have been paid off. It is an important calculation for managing cash flow and positive working capital.
A working capital ratio is calculated by dividing total current assets by total current liabilities. It is a measure of liquidity, which means the ability of the business to meet its obligations as they fall due. For this reason, it is also known as a current ratio.
How Working Capital Management Is Important For Your Business
Working capital management affects the success of your business and how others perceive your business. In other words, is your company well-managed or a bankruptcy risk?
The effective management of working capital is critical to a company’s financial health and operational success as a business. Good business management can ensure a solid balance between growth, profitability, and liquidity.
Finance teams should have a clear view of how much cash is available at any given time and work with the business to keep enough working capital to cover liabilities, plus some room for growth and contingencies.
In conclusion, working capital management is an essential component of every successful business. It is vital for a business to effectively manage working capital and access it on demand. Revenue based financing companies do thorough research on the borrowing businesses and their working capital ratio, among other factors, to ascertain the financial health and repayment capabilities. If you wish to avail of Working Capital Loans, please click here.