Last updated on August 21st, 2024 at 06:34 pm
Working capital is one of the most important aspects of a business. In recent years the world has witnessed surging growth in the development of large-scale and small-scale companies. These companies have faced numerous challenges in gathering formal credit for their working capital and tracking the cash flow. These factors have affected the growth of these companies.
Therefore, a company needs effective working capital management that optimise the cash flow and can enhance the operational work of the company. This management also allows a company to track its current liabilities and current assets so that its obligations can be reduced rapidly.
A senior management course will assist the senior managers of your company to learn more about working capital management and its functions. This will educate the existing employees in the company and will reduce the cost of hiring new employees.
Let's dive into this article to learn more about working capital management!
What Do You Understand by a Working Capital?
The amount of liquidity that is available for a company through which it performs its daily operational works is termed working capital. You can calculate the working capital of a company by performing a subtraction between its current assets and current liability. The current assets are the money that is available in the bank and can be converted into cash whenever the company requires it.
On the other hand, current liabilities mean the current loans that the company needs to repay to the lender. A company will have a positive working capital when there are more current assets than current liabilities. If the situation is quite the opposite then the working capital of the company turns out to be negative.
If you wish to learn more about important management topics such as working capital management, a senior management certification can definitely help you.
Definition of Working Capital Management
All companies need to manage their short-term assets and current liabilities this procedure of managing a company’s capital is termed working capital management. This management supervises a company’s inventory, current cash, as well as loans. It helps a company to have a continuous cash flow without hindering its operational works.
Continuous cash flow is maintained by working capital management simply by maximizing efficient operations that eventually cut off expenses and short-term loans. Working capital management also allows a company to reduce the number of loans from financial institutions.
Companies Using Working Capital Management in Real-Life
There are renowned global companies that use working capital management just to maintain a continuous cash flow. Here are a few examples of such companies:
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Walmart
Walmart is one of the most trusted and famous companies due to its efficiency. This is because Walmart owns one of the most successful working capital management. It also has one of the finest supply chains in the States.
An efficient supply chain management will guide a company to have a lesser number of inventories that also decrease the various working capital requirements.
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Apple
Apple manages its working capital by simply having a negative working capital, this is a unique strategy of this company. This is done because it directly takes capital from the consumers before paying it to the suppliers. This model allows the company to use the money of its suppliers for various operational work.
The senior management team of a company heads the working capital management system of that company. Hence to learn more about this team you can join an online senior management course.
What are the Objectives of a Working Capital Management?
There are a few important objectives of working capital management. These objectives have been vividly elucidated below:
- The main object of working capital management is to ensure that a company does not face any problems while operating the business. It creates a smooth trajectory right from the collection of raw materials for production to the delivery of the end products to the consumers.
- Working capital management also tries to increase the returns that the company has invested in various investments upon its current liabilities. This means the valuation investments are higher than the funding of the current assets.
- The cost of capital is also controlled with the efforts of working capital management. This is executed by negotiating with the financial institutions and selecting the most suited mode of finance.
- Working capital management also optimises the profit margins of a company. If there is a delay in purchasing the raw materials then there is going to be a late delay in producing the final products which creates a huge loss for the company. Working capital management ensures that this scenario does not take place.
Effective working capital management is an important part of financial management and it allows companies to reach their financial goals effectively.
Importance of Working Capital Management
Working capital management plays a crucial role in maintaining the finances of a company. Here we have stated why working capital management is important:
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Cash Flow Management
A company needs to effectively manage its cash flow and hence it needs to reduce its external financing. Working capital management comes in such scenarios to rescue a company from getting insolvent by simply managing its daily capital and tracking the liquidity.
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Efficient Operations
Efficient working capital management is important in a company so that all the operational works can be smoothly carried on. For example, if a small company has an inventory with overstocking then this management would help it to control this situation as extra inventories require more space as well as capital.
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Relationship with the Suppliers
To earn great credit terms and discounts a company must maintain a good relationship with its suppliers by sending them all their pending payments on time. Effective working capital management allows a company to build a good relationship of trust with the suppliers by sending them their pending payments on time.
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Customer Relationship
For a continuous cash flow, a company needs to establish a good relationship with its consumers by making them happy with the end products and gaining their trust. Working capital management can easily create a good customer relationship by collecting customer data and analysing them.
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Reduction in Financing Costs
Working capital management allows a company to reduce its financing costs. This allows a company to discourage taking short-term loans and credits that hinder the current assets.
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Various Opportunities for Investments
With the assistance of working capital management, a company can save a lot of capital that can be invested in lucrative opportunities that have a high rate of return. Otherwise, the surplus capital of the company can be used during any economic crisis.
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Sustainability
Often companies earn very negligible profits. In such scenarios, working capital management assists these companies, in the long run, to be sustainable and profitable. It also prevents a company from becoming insolvent by maintaining a continuous cash flow.
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Risk Controlling
Companies are often extremely vulnerable to economic downfall, market crashes, and other catastrophic events. These events cause economic shocks to these companies. Working capital management helps these companies save adequate capital so that they can control the risk of business failures.
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Flexibility and Adaptability
There are certain instances when companies may face unexpected circumstances where there may be extra expenditure or changes that might hamper the working capital. Working capital management allows a company to be flexible enough so that it can adapt to such a situation.
Calculation of Working Capital
There is a formula for deriving the working capital of a company. If you take away current liabilities from current assets, you can easily derive the final working capital of a company. The formula is:
“Current Assets – Current Liabilities= Working Capital”
Current Assets
Current assets are those that a company can convert into cash at any given time. This asset must be utilised within the usual operating business cycle or a year. Here are some examples of current assets:
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Cash
Cash refers to the available money a company has in its bank account that it can use for business purposes at any time.
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Inventory
Inventories are those products that are yet to be sold to consumers. They are either in the form of raw materials or in the form of final products that can be found in retail stores.
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Accounts receivable
Account receivable is the money that a company will receive from its customers for the products as well as services that have been sold or given on credit.
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Prepaid expenses
Prepaid expenses are the last example of the current assets. These are the advanced payments that are made by the consumers to the company for some services that they will avail of in the future. Insurances are one of the most popular examples of prepaid expenses.
Current Liabilities
Current liabilities are the debts and loans that a company needs to repay within a year or the usual operating business cycle. Here are some examples of current liabilities:
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Short-term loans
Short-term loans are one of the perfect examples of current liabilities. These loans need to be repaid by the company within a period of 1 year.
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Bank Overdraft
When a company withdraws more of the available money from its banks it is termed a bank overdraft. This is another example of current liabilities that a company has to face while carrying out its business.
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Accounts Payable
The money a company needs to pay back when it takes goods or services from its suppliers on credit is termed accounts payable. This is another kind of current liability.
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Unpaid Liabilities
When a company uses some services without payment is known as unpaid liabilities. Some examples of unpaid liabilities are utilities and wages.
What are the various Working Capital Ratios?
Current Ratio
The liquidity ratio that decides if a company is capable of repaying all its obligations, liabilities, as well as short-term loans is called the current ratio. Most of the investors of a company are interested in knowing this ratio so that they can analyse if a company can easily optimise its current assets as per the balance sheet.
Formula: “Current Assets ÷ Current Liabilities = Current Ratio”
Quick Ratio
The quick ratio is slightly different than the current ratio as it considers those liquidities that can be quickly converted into cash.
Average Collection Period Ratio
The average period that a company takes to collect all its receivables is known as the average collection period ratio. This ratio allows a business to get a better idea about its cash flow and plan a strategic business plan accordingly.
Formula: “365 days ÷ Average Receivable Turnover Ratio = Average Collection Period Ratio”
Inventory Turnover Ratio
The inventory turnover ratio shows how well a company is using its inventory and the number of inventories it is selling within a particular period.
Formula: “Cost of Sold Goods ÷ Avetage Inventory at Selling Price = Inventory Turnover Ratio”
Things that can Influence the Performance of Working Capital Management
It is important to have efficient working capital management that can easily optimise the cash flow of a company so that it can run without any external hindrance. However, certain factors can highly influence the performance of working capital management. These factors are:
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Scale of Operation
The scale of operation is one of the first factors that have a direct influence on the working capital of a company. A small-scale working capital is required if a company is working on a small-scale operation. On the other hand, if a company is working on a large-scale operation then it requires a large-scale working capital.
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Production Cycle
The next factor that has a high influence on working capital is the production cycle. For a long production cycle, a company will require less working capital which is in the form of raw materials or inventories or semi-finished products. In a shorter production cycle, a company will require less working capital if it is compared to a longer production cycle.
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Business Cycle
The third factor that has a direct impact on the working capital is the business cycle. When there is a rapid economic boom, the sales of the finished products rise along with the working capital of a country. Similarly, when the economy of a country is facing recession the sales of the finished products go down along with the working capital of a company.
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Accessibility of Raw Material
The last factor that has a direct influence on working capital is the accessibility of raw materials. When there are sufficient raw materials then a company does not need a huge working capital. However, if there is a crisis of raw material then very little working capital will be required by a company if it is compared with the normal situation.
How can Working Capital Management work Effectively?
For efficient working capital management, a company has to plan out successful strategies that will work without any failure. Here are some of the strategies that a company has to follow for successful working capital management:
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Financial Analysis
For efficient working capital management, a company should schedule financial analysis either in a monthly interval or a yearly interval. This analysis will allow a company to understand where it's making financial mistakes and this will allow a company to grow further. A financial analysis monitors the patterns of inventory, accounts payable, and accounts receivable.
Tracking these patterns and analysing these insights help a company to create strategic financial as well as working capital plans for the next financial year.
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A Good Inventory Management
Good inventory management is another strategic measure that a company can take for efficient working capital management. This helps a company maintain an optimal level of inventory. This management helps a company reduce the capital that is required for extra storage and works on better customer satisfaction.
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Performance Indicators
Performance indicators or KPIs are also important for efficient working capital management. It tracks the company’s accounts receivable, accounts payable, and inventory so that the indicators can tell which areas need to be improved and what strategies should be followed for better performance.
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Continuous Supervision
A company must supervise its capital daily to achieve good working capital management. Supervision and reviewing allow a company to comprehend the capital position and identify the potential threats. The company must immediately take action against the threat before it becomes a huge economic risk.
Continuous supervision also allows a company to achieve all its financial objectives for the current financial year.
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Terms with Suppliers
Negotiating the terms with suppliers also allows a company to have efficient working capital management. If a company can negotiate its terms with the suppliers then it will have more capital that can be used for immediate important operations.
Conclusion
For a small company, it is extremely crucial to make a strategic financial decision on working capital, hence working capital management is extremely essential in such a competitive market. This decision has an impact on the finances and growth of a company. Hence, companies are actively hiring senior managers who can easily manage the working capital.
A solid senior management certification programme can help you learn how to effectively manage working capital and other crucial financial management skills.
To commence a career as a senior manager you can enrol yourself in the new online senior management course launched by Imarticus Learning. This is a collaboration with IIM Lucknow, where you can learn this course under the guidance of an experienced faculty. So without any further delay join this course to bag alluring opportunities and facilities.
