Setting up and running a business is a very demanding undertaking but well worth it once things get going. There is a lot to do when it comes to running a business, from monitoring the fluctuating market conditions and signing up new clients to finding business premises and investing in equipment and software. But while these are all vitally important, you need to ensure working capital management remains a priority. Here’s why an advanced inventory control functionality is worth considering.
What is working capital management?
To put it simply, working capital management is the difference between your company’s assets and its liabilities. The capital you’re currently working with right now. The assets include your current cash, inventory and accounts receivables. The liabilities include short-term loans, any accrued liabilities, and accounts payables. This is monitored or managed across various departments to ensure that your business has a positive cash flow at any time. Using various strategies, you can ensure your company is leveraging your assets and liabilities for a smooth flow of operations.
What are the elements of working capital management?
When it comes to working capital, a few accounting elements need to be monitored constantly to ensure a healthy cash flow. These include:
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Accounts receivable
This refers to all the money that is owed to your company for the services or goods you’ve provided but have yet to be paid for. You’ve invoiced your clients, but they will have a period of time to make payments. The accounts receivable can actually be used as collateral for capital without creating further debt.
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Accounts payable
On the flip side is accounts payable, which is all the outstanding bills your company is owing to other service providers. There are often discounts for early payments, but some companies prefer to delay payments to maximise the positive cash flow. While net terms – paying 30 or 60 days after the fact – can benefit larger companies, you might want to consider paying quicker as a small or medium enterprise.
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Assets and inventory
All your business inventory is currently an asset as it can be sold and converted into capital within a 12-month period – the cash conversion cycle. This is why it’s included in your working capital management – how you manage your inventory impacts the operational efficiency of your business.
How do you calculate working capital management?
Managing your working capital is vital to the financial health of your business, and it’s actually really simple to calculate. It’s worth performing these calculations regularly to monitor the working capital.
Current assets – current liabilities = working capital
You can also work out the working capital ratio to determine the company’s overall financial health, rather than just the working capital at a period in time.
Current assets / current liabilities = working capital ratio
This formula should result in a positive number, but you don’t want the number to be too high. The ratio should also be at least one, showing that the company has the same number of assets as liabilities. The working capital ratio of two means twice the number of assets as liabilities … and so forth.
What impacts working capital management?
We’ve looked at some of the elements that go into the calculation of working capital management. However, several other elements factor into the business’s health. These include:
- The scale of operations: Whether the business is a corporate venture or small-scale operations will determine the amount of working capital required.
- Industry: Whether you’re a retailer or manufacturer, the type of work you do will also impact the working capital.
- Seasonal business: Connected with the industry is whether or not the work done is seasonal or not. Working capital will be needed to conduct business during the busy periods, and it will be needed to get you through the quieter months.
- Materials: If you’re in an industry reliant on materials, such as manufacturing, the availability from suppliers will impact how much working capital is needed.
- Inflation: Rising inflation means rising prices which requires more working capital to secure goods and materials.
- Growth potential: If you’ve secured a big contract, you might require more working capital to get things going.
- Operating efficiency: The time it takes from production through to sales will impact how much working capital you need to sustain your business operations.
Benefits of working capital management?
With a solid grounding in what capital management is, how to calculate it, and what impacts it, you might still be wondering why working capital management is so important.
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Financial indicator
The reality is that if anyone wants to come in and measure your company’s financial health, then they would look at your working capital management. This is because working capital management is a great reflection of how well a company is doing in terms of managing debt, making payroll, earning revenue and dealing with inventory.
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Daily operations
Working capital management will impact day-to-day operations as it covers your financial obligations related to paying service providers and staff.
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Efficiency of your organisation
Good capital management is an indication that you’re managing your inventory, liabilities and assets well and that company is actually solvent.
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Investment potential
For those looking to invest, the business’ working capital management shows that it is well run. It can meet its financial obligations and is a worthwhile investment opportunity.
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Business advancement
When you have efficient working capital management, it indicates your business can maintain liquidity while leveraging assets for investment. This provides your business with significant room for growth and expansion later on.
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Avoid cash flow problems
Finally, working capital management will help you avoid cash flow problems that could place you in a financially risky situation. With business foresight, you can enjoy a higher rate of return on your capital, thereby increasing profitability, liquidity and appreciation.
How does advanced inventory control functionality help?
To ensure you manage your working capital better, you could consider an advanced inventory control functionality, as offered by Omni Accounts. This helps monitor stock at multiple warehouses, including serial and batch numbers, bar codes, and bill of materials. And, for assistance in creating financial reports and checking whether key performance indicators are being met, Omni Accounts provides customised software for financial dashboard creation.
Get in touch with Omni Accounts today to find out more.
