Working capital refers to the money in your company’s account, which is used for its everyday operations. It’s essential to keep these proceedings working smoothly which means managing capital well. This in turn, helps keep your business in check and helps avoid bankruptcy.
The Calculation of Working Capital
In simple words, the working capital formula is the amount of money obtained by subtracting the figure of current liabilities from that of the current assets. If the company’s working capital holds a positive value, then that means the organization is working effectively and smoothly. On the other hand, if a company has a negative working capital, it means there are some serious issues in regards to how it’s functioning. The objective is to have $2 as current assets for each $1 of current liabilities, which signifies that you are actually making money. The 2:1 ratio is considered the safe limit.
In order to make sure that your company is working smoothly, you have to keep yourself updated on its daily activities. Business operations and financial obligations would need to be taken care of. Note that excess of the working capital is also unfavorable for the company because it could lead to reduced shareholder value and reduced profits. The success of your business is governed by how effectively its working capital is managed.
Methods to Improve Working Capital
By applying certain strategies to your business, you can successfully bring the working capital close to the ideal 2:1 ratio. Below is a discussion of six strategies to help improve your working capital. Note that every single one of these demands are analyzed in different departments of your business and are brought in line with the most optimal performances. This will ensure that the efficiencies and processes are improved enough to create a positive flow of cash while reducing expenses.
Get Better Accounts Payable
You can negotiate with your distributors and suppliers to ensure the payments are at the most favorable terms for your company. There is always room for improvement if you keep updating the current terms and conditions. There should be a timely review of payment terms on your accounts payable. Moreover, also ensure the propriety of your accounts receivable. The balance should be maintained so that the company benefits from the overall flow of capital.
Advance Accounts Receivables Collections
Ensure that the receivable accounts are collected in a timely manner. You could take several approaches to do this. First, motivate your customers to make timely payments. You could use payment incentives for this purpose, and inform customers regarding the benefits. Furthermore, you could set up incentives for your company’s collection team. Policies and rewards could motivate your team to ensure the timely collection of invoice payment.
Examine the Credit Risk
Run a thorough scan of your customer base and assess the probability of repayment. Next, segment according to the possibilities you are able to identify to make the collection process easier. This, in turn, will improve the cash flow. Adding incentives and penalties is a part of this, and your efforts are bound to bear fruit in the end.
Check Your Expenses
Make sure you review your variable and fixed costs on a regular basis. There’s always room for reduction in expenses if you are open to changes in associations and suppliers.
Settle Better Pricing with Suppliers
Make sure you run a timely review of your supplier associations. Always try to negotiate towards the best pricing. If there is a need to replace them, do not hesitate to do so. The working capital of your company is of the utmost importance, and you should take all the necessary steps in that direction.
Evaluate Tax Opportunities
There should be a consistent analysis of the taxes your company pays. Make sure that you are not overpaying your current ones. Bring the company to its best tax position possible.
