Ask any business owner, big or small, what the biggest challenge is when running a company, and they will tell you it is managing finances. What makes it so difficult? Many people feel that a company will only function successfully once it has acquired clients. While this is partly true, what is equally important to a company’s success is how well it can manage, and strike a balance between the funds that come in and go out.
As a small business owner, it is important for you to know how to manage your company’s short-term finance, also known as working capital requirement. Remember that this capital requirement for your company will differ from another company. From earnings to expenses, there are various factors that determine the exact working capital requirements for businesses. So, what are the factors that play a part in this? Take a look at some of the most common ones below.
- Type of business: Your company’s working capital requirement depends on the kind of business you run. For instance, trading businesses require lower amounts of working capital as goods are bought and sold immediately.
- Business cycle: Different stages of a business cycle can also affect your company’s working capital requirement. Higher working capital is required when demand for your products and services is high; while less working capital is needed during a decline in demand.
- Scale of operations: Your working capital requirement is directly proportional to the scale of your company’s operations. This means that bigger organisations require higher capital, while smaller organisations need less capital.
- Growth potential: A company’s growth potential is related to the scale of its operations. This means that if your company has higher growth potential, its working capital requirement will be high as well.
- Credit workings: Businesses that can get raw materials easily on credit will not require a lot of working capital. Similarly, those that sell products or services in cash payments will not require as much working capital as compared to those that accept credit payments.
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Why is it important to effectively manage working capital?
One of the most important reasons for effective working capital management is to help you reduce the cost of capital. What is cost of capital? This is the money you spend on ensuring a healthy working capital, through monitoring and management. In addition to this, another objective of management of working capital is to help you maximise returns on invested assets.
Effectively managing your company’s working capital will also ensure a smooth operation-cycle and a well-functioning business. Right from obtaining raw materials to delivering the final product, working capital management ensures a smooth overall process.
Now for the big question
So, how do you manage your business’ working capital requirements? Remember, how you operate this is vital to your company’s long-term financial health. Your company’s working capital includes no conditions and is free of interest, which means it is the easiest and fastest cash-source for your establishment. Listed below are some tips to help you better manage your working capital requirement.
Evaluate your current status
The first step is to assess the patterns of your company’s assets that are both, incoming and outgoing. This will help determine trouble areas, like late invoices or payers. The information will help you match the cash inflow and outgoing amounts, so that you can create a balance that will ensure better functioning of your business. It will also prevent business operations from getting affected in any way.
Strengthen supplier relationships
If possible, strike a deal with your suppliers to stagger large cash payments, as it will decrease your liquidity burden. At the same time, try to get better conditions from your suppliers, such as longer payment terms.
Check inventory levels
Tracking your inventory, as difficult as it may seem, is necessary to maintain a balanced working capital. It will give you a better picture of all your stock, and that can make it easier to identify and avoid any surplus stock that affects your company’s cash flow.
Try to work out an agreement for deposits on selected contracts or from certain customers for faster payments. Alternatively, any amounts due from customers should be collected as soon as possible. To encourage faster payments, you can even offer discounts. This will ensure your business has constant cash flow.
From time to time, review and analyse this process, and continue to look for ways to improve your short and long term financial management. This is especially crucial for start-ups as it can create the foundation to a successful business.