Introduction

Every business, regardless of size and industry, needs to understand its company’s working capital cycle. The working capital cycle is the length of time it takes from producing a product or service to receiving payment for that product and service. A longer cycle represents a longer period in which a business has tied up resources without receiving cash to further invest or pay business expenses and obligations.

Fully understanding all components of the working capital cycle is an important part of business viability, as it allows for better management of cash flow, and it is widely known that not properly planning for cash requirements is a foremost cause of the failure of small businesses.

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What is Working Capital Management all about

Working capital is calculated by taking current assets (accounts receivable, cash and equivalents, and any inventory) minus current liabilities (including trade payables, other payables, and debt). If the current assets are less than its current liabilities, there is a working capital deficiency – but it is also possible to have significant working capital and still have a cash flow problem because of a lack of liquidity within current assets.

Working capital management refers to the way in which a business manages its assets and liabilities to ensure that it can meet its obligations.

Efficient working capital management ensures that any company can run smoothly while being able to repay maturing short-term debt and expenses that might rise soon. In working capital management, the most basic tasks revolve around managing inventories, accounts receivable and payable and cash.

Working Capital management involves the balancing process of the requirements of short-term assets and short-term liabilities. The working capital management includes short-term funding, products purchased on credit, products and services furnished on credit and merchandise, products and services paid for upon delivery.

Handling the working capital basically involves cash flow management of a business on a daily, weekly and even monthly basis in such a way that satisfies all the debts at the same time reserving sufficient capital to carry on operations and the profits generation.

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Tips to Improve Working Capital

Accounts receivables, cash in hand, inventories, marketable securities and prepayments are current assets that will become cash within a short period (usually 12 months) and likewise, account payables, wages to be paid and unearned revenues are current liabilities that need to be settled within that short period as well. Although it does not apply to all industries, good working capital management typically involves keeping the current assets consistently higher than the current liabilities to avoid financial complications or operational problems arising from having to settle liabilities without having the cash to pay for them. In some jurisdictions, unpaid liabilities tend to carry some penalties and interests that will keep increasing.

Here are some small tips that can help manage working capital more effectively. Keeping an eye on these should allow for growth and prosperity –

1. No Idle assets

The most efficient way to guarantee good working capital is to ensure that there are no idle assets. All assets owned by the business should have a clear path to generating revenue and cash for the entity. For instance, if a business has extra space, it can consider leasing or subleasing to earn rental income. Assets that do not generate much income and that are costly to maintain eventually turn out to be liabilities.

2. Manage and Reinvest Free Cash

Extra cash available to the Company as a distinct advantage as it can generate quick returns in a noticeably short term. If there are payables due of ₦3m to settle by the 31st of July and there is extra cash of the same amount available to the Company as of date. Instead of paying due early, a portion may be invested as a short-term fixed or call deposit. The return may not be much, but it will yield something that will add to the cash balance. There are also great benefits in compounding interest even if the rates are small.

3. JIT Inventory

Just-In-Time inventory allows a business to cut down on costs involved in transporting and holding stock. Materials are purchased and received in time for the production line or for sales. It also takes away the risk of stock items being slow-moving, damaged or obsolete since the items remain with the supplier.

4. Reduce Receivables in Time and Amount

While it is advisable for small businesses to attempt to have a cash-heavy sales process, it might not be possible if a business wishes to achieve the sales level it requires for operations. Nevertheless, the goal is to shorten the amount of time customers take to pay invoices. A business could offer a period of 30 days till Invoice due date and offer a cash discount if the same bill is cleared in maybe, 10 days or less. This allows for more sales in a short time and pushes customers to pay early to take advantage of discounts. The longer an invoice is left unpaid, the more the cash loses its value and there is also chance that a business will spend some unnecessary costs in collecting the invoice.

5. Alternative Funding

Businesses must always be on the lookout for financing that is beneficial to the business. The most readily sources of funding might not be the cheapest. Also, working capital loans must be strictly used for such purposes to avoid complications that may arise from a breach of contract.

6. Timely payments to suppliers

This is the easiest and simplest rule to follow. It is understood that if suppliers and vendors are paid on or before due dates, the business can negotiate better deals, get discounts, and avoid potential fines and penalties associated with overdue payments.

7. Group Purchasing

A small business might not always have the funds to buy the required levels of items that trigger volume discounts. It might be a good idea to collaborate with the competition to pool resources to get the stock from the supplier. That way, Inventory costs are kept low, and cash is saved for the Company.

8. Leverage Technology

We have touched on this in a previous article, leveraging technology provides efficient cost-saving benefits for a business.

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Conclusion

Small businesses are not much different from established business giants. They just have a smaller market footprint. Taking working capital management seriously and handling the details through which cash flows are dealt will make business a more profitable one. This, combined with social media, ecommerce, and data science, can work wonders for a small business. Follow our blog to learn more.