Working capital management can be defined as the process of managing short term or current assets and short-term or current liabilities. Short-terms assets are composed of loans and advances, inventories, investments, debtors and cash and bank balances.
On the other hand, short-term liabilities have the following components: trade advances, creditors, provisions and borrowings. It is advisable for you to effectively manage your working capital, so as to ensure that you minimize risks and continue to be profitable.
The Basics of Effective Working Capital Management
Working capital, which can be defined as the available cash on hand for the daily operations of your business, can actually be affected by a number of factors. These factors include external issues such as the business and legal environment as well as internal mechanisms such as information systems and organization structures.
Undue focus on the task of producing good quarterly sales results can also be expected to have a huge impact on your working capital. It can negatively affect your working capital performance. If the operations of your company have marked seasonality and your working capital requirements vary from one quarter to another, then there is also a great chance for your working capital performance to be negatively affected.
If you want to perform effective working capital management, then it is advisable for you to skillfully manage the finances in other aspects of your company including debtors, creditors and tangible assets. Debtors or those customers who purchase goods and services from you on credit hold the health of the working capital of your business in their hands even if the term is just thirty days.
If these debtors cannot make their payment on time, then you can expect your cash flow to be seriously affected. This will cause a lot of trouble to your working capital. Because of this, you need to make sure that you take the necessary action to make your debtors pay on time. You may also move those problematic accounts into a cash only basis before these accounts start to cause a lot of strain to your funds.
If you want to effectively manage your working capital, then it is also advisable for you to keep the creditors of your business at a minimum, both in accrued balances and number. If it is possible, you should make it a point to make early payment discounts. You should also consider paying cash at the earliest possible time to avoid paying higher amounts of interest. This way, your debts will never cause a lot of damage to your working capital.
It is also advisable for you to carry high levels of tangible assets and inventory, if you want to undertake proper working capital management. This move is considered to be good for your revenues and your entire business. However, you have to make sure that you only carry high levels of inventory when the demand is also high.
When the demand is low, the act of carrying a great number of inventories can have a negative impact on your cash on hand. If your inventory is already tied up in cash, then it is advisable for you to immediately take action to increase your sales as this can rebuild the level of your cash. This will allow you to keep a healthy working capital for your business.