The working capital of a business is defined by which the company’s current assets exceed its liabilities. Working capital is an essential numerical figure that is carefully analyzed by most companies. It is mainly used as a source of finance for frequent operational activities that include wages and salaries, revenue expenditure, catering overheads, and ensuring consumer demand is met with the existing production resources and potential of a business. Small businesses have to closely monitor their cash flow to avoid the unfortunate circumstance of running short on liquid assets or cash specifically. They need to be interactive from finding the perfect balance between improving the collectible period of business and delaying the payables to containing sufficient funds to paying off short term debts without the expense of losing return on investments on their preexisting and acquired assets.
Such factors are quite essential for small businesses and have to be regulated often, considering their recent introduction into the industry could pose a threat to other related companies. It could ultimately place the business’s financing opportunities in a vulnerable position. The perfect working capital situation for a company is when your current assets are sufficient enough to counter your current liabilities, the ideal ratio being 2:1. If your working capital is negative and amounts to a rate lower than that, then the going concern of the business is doubtful. However, bear in mind a ratio higher than the ideal depicts the fact that your investment opportunities are being overlooked. For smaller companies, it is common to have lower working capital ratios, and to assist you in just that, we have listed down four ways you could improve it.
REDUCING SHORT TERM-DEBTS
Debt could be an unavoidable factor for smaller enterprises, and in most cases, it is the sole source of finance. Working with loans, for instance, it is crucial that you lookout for a suitable loan with reasonable interest rates or loan origination fees. Short term loan interest rates typically vary, but searching for the right one could be beneficial for your business. Reducing your short term debts improves the life of your cash flow, which creates a positive and immediate impact over your current asset figure. It is one of the instant and easiest ways for you to improve your company’s cash flow.
IMPROVE CREDITORS AND DEBTORS BALANCE
Another secure method out there that could significantly raise your working capital ratio is to readjust with your creditors and debtors. In the case of trade receivables, we recommend you to provide them with an incentive to pay back earlier, a cash discount, for instance. Encouraging your customers to pay on time to collect outstanding invoices would directly increase your current assets and, thus, your overall working capital. As far as trade payables are concerned, it is best to delay the payment period and improve the management of the accounts payable process. It could be advantageous for you if your suppliers were also your customers. This way, you would have an easy go on discounts, and a mutual understanding could help you delay your payments or seek early receivables, depending on what your ideal situation calls for. Balancing the amount and receivable terms could prove to be favorable when raising your working capital figure.
LOOK OUT FOR REASONABLE PRICES
We understand how most small scale businesses tend to rely on one another and desire to be loyal customers to their initial suppliers. However, you must look out for prices that are reasonable for your company’s production. It is best to timely review your contracts and negotiate for better prices whenever you can, in the case of the supplier not being cooperative enough to do so, it might be time for you to realize that you need to look out for other suppliers with comparatively reasonable prices. Loyalty must not always come in the way of your business if you wish for it to expand and continue operations. You could also check your internal mechanism of the business production and review your fixed and variable costs to seek opportunities (if there are any) where you could improve your cash flow and, ultimately, your working capital. Bulk buying from a single supplier could allow you to negotiate better and land yourself some pretty decent discounts.
CREATE A PROVISION FOR DOUBTFUL DEBTS
While you are out there analyzing other factors of the business, do not forget to segment and identify the possible credit risks your company might have to bear. To improve your cash flow and overall functionality of the business, you could always assess some underlying factors, such as the likelihood of distributors differing from one another by selling to customers who prefer purchasing through cash rather than credit. Adding penalties for your credit customers and incentives for your suppliers could assist you in amending your credit profiles and reducing risks.
Apart from these, other factors include reviewing your tax and the incentives it holds, managing your inventory, assessing interest payments, using updated information, etc. While most of these methods solely focus on ways for you to raise your working capital, you must note that ‘improved’ working capital does not necessarily mean a very high ratio. It could also be detrimental. In most cases where your working capital is high, it portrays your inability to use the excess working capital to generate more profits for the business. Therefore, you must stay close to the preferred 2:1 ratio as an ideal circumstance.