However, before delving into the specifics of the management of working capital, one must clearly understand what it is and why it is crucial for any company. A thorough understanding of the concept will help one understand its subtle nuances and manage it competently.
What is working capital?
In its simplest definition, working capital is the gross difference between a company’s current assets and its current liabilities. Current assets refer to the cash currently at hand, accounts payable (mostly, in the form of unpaid bills) and existing inventory. Current liabilities include accounts payable, credits payable and accrued expenses.
In other words, it refers to the liquid money available with an organisation to run its day-to-day operations. The ratio between current assets and current liabilities determines whether a business organisation is adequately prepared to meet its short-term expenses. In fact, it acts as a metric of a company’s short term financial health and has the potential to make or break a small business.
Also known as business capital, it can be subdivided into the following categories.
Based on the balance sheet
- Gross working capital (GWC): Current assets available to a company which can be liquidated at a short notice.
- Net working capital (NWC): Difference between current assets and current liabilities per a company’s balance sheet.
Based on the operating cycle
- Fixed or permanent working capital: The lowest NWC available to a company on a particular financial year.
- Variable or temporary working capital: Difference between NWC and permanent business capital.
Effective business capital management depends on an in-depth understanding of these concepts. How much working capital a business needs varies depending on various factors such as their size and stage of development.
Management of business capital: The what and the why of it
Working capital management is arguably the single biggest determinant of the success or failure of a business organisation. An effective strategy, outlining the key pointers of liquidity management, is pivotal for a company’s growth. When a company has inadequate cash flow to pay for its deliverables and other liabilities, it faces the risk of liquidation and eventual bankruptcy. A Working Capital Loan from reputable NBFCs like Bajaj Finserv can help avoid situations like that.
Benefits of managing working capital efficiently
It is critical for every company to monitor their business capital minutely and take necessary steps to ensure that they have adequate liquidity options to meet their financial obligations in the short term. There are several other benefits of capital finance loan as well, some of which are mentioned below.
- Improves credit ratings
Since working capital determines a company’s ability to meet its short-term financial liabilities, it has a direct bearing on the company’s credit rating. Effective business capital management ensures that an organisation has enough resources to pay back any outstanding debts timely, which reflects on their credit profile.
- Ensures greater liquidity
Effective business capital management ensures that a company has adequate liquidity options and do not have to rely heavily on external financing. It is especially crucial for small businesses which transact mostly in cash. Business capital management in such circumstances is nothing but cash flow management.
- Maintains uninterrupted production
This is especially applicable for manufacturing houses, which have to bear the cost of raw materials, labour, production equipment and various other overhead costs. Lack of working capital can potentially stall their production as these liabilities need to be paid off up front.
- Helps avert crisis
A business that has an efficient business capital management strategy is better suited to sail through any impending catastrophe. They can even ramp up their production in case of emergency orders.
Managing current business capital is a prelude to the management of other business resources. No healthy business enterprise can afford to take it lightly.