Working capital is an indicator of how much liquidity is available to a business for running its operations. It is calculated by subtracting current liabilities (such as debts and payables) from current assets (such as cash on hand and account receivables). The difference between the two defines the scope of efficiency, sustainability, and scalability of a business.
If positive, it means a business is in good financial health. If negative, on the other hand, it can reveal that the finances of a business are poorly managed and it may be on the verge of going under. Therefore, through effective working capital management, a strong operational foundation can be built and a growth trajectory can be maintained. Here is how that happens:
Impact of Working Capital Management on Businesses
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Operational Expenses Management
Your first concern while running a business is ongoing expenses such as inventory purchase and carrying costs, salaries, rent, utilities, and payback of outstanding loans or mortgages. If these are not managed effectively, you wouldn’t be able to build and deliver value to your customers. Forget about generating profits; you won’t be able to break even!
Thus, to ensure a smooth running of your business and execute key activities without fail, working capital must be managed effectively. By focusing on increasing customer payments and realizing accounts receivables, your current assets can steadily increase. At the same time, if delays in positive cash flow are inevitable, you must also be prepared to source and raise a working capital loan.
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Cyclic Demand Fulfillment
Demand cyclicity allows businesses to increase their returns manifold. However, in order to handle cyclic demand increases, your business also needs to have resources and capital. You should be able to buy and hold additional inventory, produce or process additional orders, onboard extra resources, and boost distribution.
All this becomes possible with a positive working capital balance and working capital finance availed at the right time.
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Positive Cash-flow for Scaling Up
Business is not just about sustenance; it’s also about growth. You need capital to scale up your operations, build new capabilities, enter new markets, and diversify. This surplus capital can only be generated through effective working capital management.
By optimizing inventory costs, expediting settlement of accounts receivables, and leveraging supplier payments, a positive working capital balance can be consistently achieved. This, in turn, can be reinvested in the business for long-term growth.
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Risk Management
Market risks, economic downturns, and changing customer demands can affect your performance from time to time. To survive drastic situations and be able to bounce back, you need liquidity and a stronghold on your working capital. Without this, you may be forced to sell off valuable assets or downsize. Having access to high-quality working capital finance under such circumstances can improve your chances of survival and minimize loss of assets.
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Reduced Cost of Capital
Taking working capital loans, repaying them on time, and maintaining a healthy working capital is a sure-fire way to improve your creditworthiness. A company’s financial health and investment risk is assessed on this basis. Thus, in order to raise capital for business growth at economic interest rates, you should start with effective working capital management.
Conclusion
In conclusion, although it is a short-term financial metric, working capital has a lasting impact on the long-term financial health of a business. Supporting your cash flow with working capital finance in the time of need can do wonders for your top-line and bottom-line.