Effectively managing working capital is a crucial business practice regardless of the phase of the business’s life you’ve reached. In a growth or start-up phase, companies can proliferate; they are unable to pay their bills and then fail. They can’t keep up with their demand for cash that is growing. Established companies must also be aware of cash flow and ensure enough working capital in order to pay expenses and suppliers when they become due.
According to my experiences, business owners tend to forget two critical issues when they are evaluating their requirements for working capital. The first is how much they need and then how they intend to be able to finance it. The process of determining your company’s “cash process” is usually an excellent indicator of your current working capital requirements. It is determined by calculating the speed at which your business converts its purchase (materials such as inventory, fabric, etc.) into cash from sales of customers.
Managing Working Capital Effectively
It is possible to use other working capital ratios or measures to evaluate the needs of working capital. Ratios like inventory turnover, creditor days, inventory turnover, and days of debt are a great way to determine the potential for problems or patterns. By regularly reviewing them, you avoid insufficient liquidity and the flow of cash. It will also allow you to act before it’s too late.
Implementing “better business practices” can help you control cash receipts from creditors (also called “accounts for receivables”). Making it easy to pay as well as establishing as well as adhering to the credit policy and making sure you follow up on late payments can all be helpful. However, it is essential to be aware of any adverse effects that could impact your customers. For instance, customers could leave your company if the credit terms aren’t favourable to them.
Being vigilant about paying your suppliers and other expenses (“accounts payables”) is equally crucial. Pay invoices on time when they’re due (rather than paying in advance). Check the accuracy of invoices and negotiate terms for credit, and making use of any discounts on payment will help. Keep in mind that while doing this, you’ll have to make sure that they continue to provide you with the materials and utilities, for example.
Economic Order Quantity
For many companies, an essential aspect of managing working capital is managing the inventory. The best stock levels, as well as the optimal time to replenish inventory, will save cash. An “Economic Order Quantity” (EOQ) calculation can help you determine how much inventory you will need. It can assist you in determining how to find a balance between “holding expenses” (warehousing space, etc.)) along with the costs of purchasing inventory (“delivery costs, etc.). EOQ will also assist in preventing your inventory from running out by setting “safety limits”.
It doesn’t matter if your business is a new venture or otherwise; managing your working capital efficiently is crucial to your business’s success.
Mark Gwilliam FCC CA is the Director and founder of Chakra Partners, an internationally recognized finance and accounting outsourced company.
He provides advice to executives and entrepreneurs in small-scale businesses on complex problems such as strategies as well as risk management, running shared-service centres and operations, and the best way to run profitable businesses. He blends his passion for sharing his expertise with his demonstrated ability to offer practical and practical solutions to clients. He’s published several books and writes regularly on business-related pieces.