Working capital management is a field of finance in which companies and business owners decide how much money they need to maintain their operations while also considering the risk involved with available financing. Working capital management includes the processes and strategies that a company may use to ensure that it has enough income each month to cover its expenses, minus any excess cash flow.Here some benefits of capital management.
Improved Liquidity
The most obvious benefit of working capital management is improved liquidity, or a company’s ability to meet its short-term financial requirements. For example, in order to purchase needed raw materials, a company must have enough cash on hand; otherwise it will not be able to purchase the materials necessary to satisfy customer demand. Liquidity is closely tied to the business cycle and highly dependent on the requirements of customers and management’s short-term goals.
Improved Profitability
Improving a company’s profitability can result in an increase in its share price, greater dividends and more available credit. Improved profitability is often the result of increasing sales and reducing expenses; however, a company can improve its profitability by improving its working capital management. Improving working capital management can increase sales by allowing the business to pay for needed inventory on time, thereby allowing it to fill customer orders. It can also reduce expenses by allowing the business to more quickly pay its suppliers, which decreases the amount of time the company spends in debt.
Operational Efficiency
A company’s operational efficiency is its ability to produce its goods and services at the lowest possible cost. When a business improves its operating efficiency, it is able to increase profits by selling its products at lower prices than competitors. Improving operational efficiency can often be tied to increasing the company’s working capital management, since working capital management can affect a company’s cash flow. Improving cash flow allows a company to purchase inventory on time and pay suppliers without extending credit. These actions can enable a business to reduce its total costs and increase profits.
Continuous Assessment of Risk Although working capital management requires the company to acquire financing, financing also carries risk that a company must be prepared to assess on a continuous basis. A company can often improve its risk management by streamlining its operational processes and reducing the amount of time that the business spends in debt. The goal is to reduce the amount of time that a company’s cash flow is tied up in inventory, accounts receivable and accounts payable.
Better Control of Cash Flow and Working Capital
Working capital management often results in better control of cash flow and working capital. The key to effective working capital management is the flexibility of a company’s cash flow, including its ability to receive short-term and long-term financing. One useful tool for managers is the ability to increase sales by using operating income or net income to fund working capital needs. Another useful tool is the ability to decrease a company’s outflow of cash in the form of accounts receivable, since this reduces the amount of money that a company must borrow.
Improved Cash Flow Forecasting A benefit of working capital management is improved cash-flow forecasting, an important aspect of the business cycle. A company can often improve its forecasting by analyzing historical data, reviewing current conditions and studying industry trends. Analysis of historical data can help a company predict future cash-flow needs. For example, a company needs to understand its historical cash-flow needs during recessions and inflationary periods, so it can plan its working capital accounts appropriately.
Balanced Working Capital Allocation Working capital management can help ensure that a business has an adequate supply of working capital as well as adequate financing. A company needs to have enough cash on hand to purchase inventory, pay its suppliers and ensure that it can continue to operate. However, if a business has too much cash on hand or in accounts receivable, it may not be able to cover its total operating costs. Therefore, a business must strike a balance between the amount of working capital that it needs and the amount that it can afford provided by financing.
Summary
The working capital management plan can be a company’s greatest asset as in the right hands, it can be used to maintain consistency in the cost of production or distribution, maintain total control over both operating and financing activities and reduce operating expenses while increasing net income.key areas influence a company’s working capital management most: accurate cash flow forecasting, proper allocation of expenses across the board and utilization of the right type of lines of credit.
We believe that an effective working capital management plan is best managed by utilizing a series of forecasting tools that should, at one time or another, be used to make adjustments to the organization’s working capital needs in order to maintain financial stability during growth.