Working Capital Management: A Comprehensive Guide

Since the inception of working capital loans, people have started actively discussing terms like working capital, working capital management etc. So, what does it mean when we say working capital management Simply put, working capital management refers to the strategies adopted by companies to manage the relationship between its short-term assets and short-term liabilities.

To understand the term/process properly, we have to understand the former term - working capital, from which the latter term originates.

• What is Working Capital?

The working capital, also known as revolving capital or circulating capital of a business, is a measure of the company’s efficiency and short-term financial health. It refers to the money every business needs for its day-to-day operations, to continue production at the same pace without any hindrances. In layman’s term, working capital is the difference between the current assets and the current liabilities of a company.

Now, when we say current assets, we mean the things owned by a business which can later be converted into cash i.e accounts receivable, bills to customers that are yet to be paid by them, cash available in business’s bank account etc.

Similarly, when we talk about current liabilities in terms of working capital, these can be short-term debts owed by the company, accounts payable to suppliers and manufacturers, accrued liabilities, and other similar debts.

• What is Working Capital Management?

As shared above, the term refers to the efficient management of the relationship between a company’s current assets and its liabilities. The same is crucial to ensure the business continues with its operations at the same productivity level and meet its debt obligations whenever they are due. In simple words, working capital management is the administration of a company’s working capital along with managing all the other aspects involved with it.

Moving on, it is very essential for all businesses to have a feasible plan to manage their working capital. This is so because the strategies employed in the process has a direct impact on the profitability, liquidity and structural health of the organization.  

• Components of Working Capital Management

Before we talk about the components associated with working capital, it would be sensible to understand the need for or the importance of working capital management.

The business process starts with purchasing the required inventory from suppliers, and later sold to the customers to generate revenue. Now, as a business you can't control your customers or how quickly they will buy your product, or how quickly they will pay you once the purchase is made. However, you owe money to the supplier and you have to pay it at any cost. But the same becomes difficult owing to the payment delays by customers. This is why an effective strategy is an imperative need to manage the working capital and the cash-to-cash payment cycle.

• The four important components/terminologies associated with WCM  

(a) Cash and Cash equivalents

(b) Inventory

(c) Debtors/accounts receivables

(d) Creditors/accounts payable

• Managing the Working Capital Cycle

The last but very crucial subject of discussion is, how to effectively manage the working capital cycle? The same can be done by following the below mentioned steps

1. Entrust your key employees with the responsibility to manage the working capital. As a part of the organization, even they have an equal responsibility to do their bit towards managing the circulating capital, and to bridge the shortfalls in a way convenient to them.

2. Paying suppliers on time and keeping the account payables can reduce the burden. You can use the cash reserve to pay the suppliers in case of any delay in the account receivables.

3. Prompt your customers to pay in a timely manner to avoid any issues in the cash-to-cash cycle.

4. Whenever needed, talk to an alternative lender and apply for a working capital loan to meet the shortfalls.

Therefore, maintain a precautionary Plan B by maintaining high loan eligibility to avoid being rejected when your business needs immediate financial support from working capital loan. On a concluding note, we would like to emphasize the role of maintaining a healthy loan eligibility as a precaution. As evident from the above-text, payment delays which cause a gap in the working capital is an inevitable thing in every business.