“Working capital” is something that everybody seems to be talking about. It is crucial to understand for people to figure out a strategy that is sound and works well with monitoring and managing a working capital. With constant advice from thousands of people, monitoring working capital can become a daunting task. This requires some insights from the experts in their field. Let us see what insights a CFO holds when it comes to monitoring working capital for a company.
Coming up with a way to manage working capital which is affordable as well as effective might turn out to be a tough task. It takes calm, cool and lots of knowledge and understanding to come up with a method to manage working capital. To understand all this better, a few more things like practical tips, step by step instructions and examples that anyone can relate to are needed.
Main accounts of a working capital
As per high-level executives and CFOs across the globe, a lack of working capital is one of the biggest reasons for companies to fail. In a broader sense, the net working capital is equal to the current assets minus the current liabilities.
Net Working Capital = Current Assets – Current Liabilities
There are four accounts in current assets and current liabilities that are crucial for working capital management.
- Accounts Payable
- Accounts Receivable
It is vital for organizations to see how best to improve the relative sizes and turnover rates of these accounts. Depending upon the business, business size, area, and other various factors, there can be an astounding variety of techniques and proposed ways to deal with advancement. In any case, the essential techniques for dealing with these records are very equivalent.
So, investigating each one of them is essential.
Most CFOs believe that cash balance is one of the most important things as it pays everyday bills. Hence, having sufficient cash balance is critical. A business faces a lot of pressure if it is unable to clear the bills, loans or any other expense. Managing to increase the cash balance without increasing the liabilities, working capital can be significantly improved. The best way to make cash is by sales. Hence, businesses increase net terms to customers to discover accounts receivable as the primary source of their cash balance.
Tied up cash amounts to inventory. Investments in raw materials and the cost of reordering expenses should be minimal for a non-stop production. It should be stricken off on a case-by-case basis by every business as it is an operational balance.
Many businesses are dependent on their stocks of items to make a profit, thus making balance inventories important. There is little good happening to the company if the stockpiles never move from the shelves. Therefore, it important to maintain a proper balance for the company.
This constitutes to all that one needs to still pay to the supplier. The ability to clear dues depends directly on how well the working capital is being managed. Accounts payable will always reflect on the ledger of the company no matter what.
Account payable (e.g. short term vs. long term, the structure of the debt instrument, price, etc) usually determines the type of financing option one chooses to go with. Most of the stress on the working capital is dependent on the financial choices as financing the operations is a critical component of a business. But only a little can be done after receiving a loan or invoice from a supplier.
It is the money that the company is yet to receive from the client. It is important to collect it in time before it gets too late. Late collection of payments can lead to harming the business in more than one way. As per one of the most reputable business blogs, allbusiness.com, to reduce the delinquent account in this tough economy, effective accounts receivable management tools are a critical thing. Insufficient funds or lack of money is one of the major reasons why more than half of most companies don’t make it past the first five years. As such, timely collection of the payments is crucial.
Assume that a business is making $4 million in sales with a profit margin of 10 %. If 5% of the accounts are delinquent ($200,000), then they will need to make an additional $2 million ($200,000 = $2 million in sales x 10% profit margin) in sales (50% more over the current $4 million in sales) to make up for the lost profit!
Obviously, it is more convenient and achievable for the business to better manage their delinquent accounts than increasing their sales by 50%.
Managing working capital runs hand in hand with managing other business resources. Other financial aspects are considered such as the ratios of the key performance, the ratios of the turnover, the ration of the collection and so on. All of these aspects can only be made possible by an efficient, standard and effective management of the working capital.