Finance and Accounting
A modern approach to working capital management
Efficiently managing the working capital of a company ensures smooth operation and flow of finances. Modern business markets have complex problems that require modern approaches and managing a company’s working capital is one such approach to meet debt obligations and operational costs. Here’s a lowdown on working capital management.
What is considered working capital?
The working capital in a business is the difference between the current assets and the current liabilities of a company. The money at hand — including profit savings, accounts receivable, inventory, invoices, bank loans, etc. — pays the bills, rents, and salaries. Working capital may be positive or negative in nature. It is positive when the assets owned by a business are more than the liabilities. Negative working capital results from having more liabilities than assets. The working capital components include these factors:
- Cash or assets that can be liquidated easily
- Accounts payable (AP) (e.g., vendor invoices, unpaid dividends, debt repayments)
- Accounts receivable (AR) (e.g., uncashed checks and uncollected business money)
- Short-term financing
- Inventory (tangible goods before they are sold)
Several factors impact a company’s working capital. These include the size of the company, its long-term business strategies, structure, and market conditions.A company’s operational decisions also directly affect its working capital.
The significance of working capital
Working capital is important for several reasons. Its role in the smooth functioning of a company makes the management of working capital absolutely essential. A positive working capital has the following uses:
- Keep the business running: An economic slump is a major event where working capital becomes relevant. It is also crucial for unforeseen expenditures or losses.
- Fund big projects: For companies that work on a project-to-project basis and are paid after completing the task, managing and balancing production costs is easier with working capital.
- Avoid emergencies: A positive working capital indicates a business’ ability to manage upcoming expenses and emergencies.
- Gain profit: Maintaining a balance between assets and liabilities with the scales bent toward assets indicates a positive working capital and hence profit.
What is working capital management?
It is a business tool for companies to effectively use existing assets and manage cash flow to meet short-term goals and run daily operations. It’s important to keep the finances balanced and cover expected and unexpected expenditures. There are three major approaches to managing working capital. They are aggressive, moderate or hedging, and conservative. With an aggressive approach, the company’s working capital investments are minimal. It is a high-risk, high-profit strategy. The moderate or hedging approach divides the total working capital into two sections — permanent and temporary. The permanent capital is the minimum amount used to perform business operations, and the temporary working capital is required for specific needs. The conservative approach is one where the company invests high capital in existing assets. Here are some practical ways to raise and manage working capital.
- Multiple collection methods: Track all pending collections with clients, speed up invoicing procedures, and smoothen client payment by accepting various payment methods.
- Request prior payment or deposits: If the company functions on a project-to-project basis, you can request the company to deposit money to fund the project.
- Look out for hidden fees: Before signing funding contracts for projects, look out for hidden fees that may not be clearly mentioned in the finance writeups.
- Stop financing new customers with revenue from the old ones: Several small companies use the revenue from a previous customer to finance the next one. Companies need to avoid this practice so that they don’t face cash flow problems.
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How can Infosys BPM help?
Working capital is a crucial day-to-day requirement for all businesses. Maintaining a healthy cash-flow balance involves intricately handling all four working capital components. With any of these goals in mind, businesses need expertise and experience to stay sharp and competitive. With a digitally powered environment, the Finance and Accounting services from Infosys BPM can empower CFOs with robust decision-making ability.