|
Working Capital is the readily available cash that helps run a business day to day. All businesses quickly realize they do not have sufficient working capital when they have difficulty making their payroll or paying their suppliers. They sometimes don't realize that there are ways to improve their working capital without putting more of their own funds into their company or by borrowing from a bank.
Working Capital is defined as Current Assets less Current Liabilities. Current Assets are cash, accounts receivable and inventory, while current liabilities are usually payables owed to suppliers and other obligations payable in less than a year that may include a range of obligations. The greater the difference between Current Assets and Current Liabilities, there is a less need for other funds to support working capital.
One of the key areas in improving the working capital of a company is matching the payment terms you grant to your customers to the same payment terms that your suppliers grant to you. The longer you have to wait for customers to pay you when you are required to pay your suppliers promptly, the more other sources of funds are needed to run the business.
First, you should be aware of what your competitors generally offer customers and then you should work with your suppliers to gain a similar period to pay them. In order to receive better payment terms a business must build strong relationships with their suppliers who are acting as creditors and also maintain a positive credit history. Just as suppliers are vigilant about extending credit to your business, you must be vigilant about your credit policy to your customers. Slow paying customers and high delinquency will impact your ability to maintain good terms with your suppliers when cash becomes tight.
Maintaining too high of inventory traps cash that could be used elsewhere in the business.. Inventory needs to be converted to receivables as quickly as possible and then collected and converted to cash quickly. Inventory that is not selling should be put “on sale” to pay off suppliers and re-order newer inventory that may be more attractive to sell.
Does your company know what the common selling terms are for your industry? Do you have an accounts receivable policy to insure that terms are only being granted to those customers who you know will abide by them? Are you checking your inventory to make sure that product is not becoming obsolete and losing its market value? Are you working to create a good credit history with the credit reporting agencies so suppliers will sell you more and at better payment terms?
These are the details of managing your working capital that if done well will lessen your need and the costs of borrowing from your bank or the pressure for you to inject more personal funds into the business.
Want to learn more about financial statements? Financial Statement Preparation Explained
|
