Introduction
Working capital management is a business process that helps the companies use their current assets effectively and optimize their cash flow. It is thus focused on enabling short-term financial liabilities and costs to be covered and contributing to long-term business aims. The goal of working capital management is to realize the highest operational efficiency.
Working capital management improvement can generate cash otherwise locked on the company’s balance sheet. This could reduce reliance on external borrowing and create fuel for growth, fund mergers or acquisitions, or be invested in R&D.
In fact, working capital can be considered one of the most important things in the health of every business. Improving your working capital position can provide a much-needed boost to the operational efficiency of a business, though effectively managing it is somewhat of a balancing act.
Effective management of accounts payable, accounts receivable, inventory, and cash helps in achieving the goal of adequate liquidity for anticipated and unbudgeted expenses as well as maximizing funds available for growth.
Objective of Working Capital Management
Hence, working capital is an important metric that businesses should worry about. It is the amount of capital they have to make payments, adjust for unforeseen expenses, and ensure that business runs as usual—well, in simple words, it is a measure of financial health. However, managing working capital is not an easy job; therefore, there could be multiple objectives of a working capital management program, such as:
Meeting obligations: The working capital management always needs to ensure that the business has adequate liquid assets to meet short-term obligations; this can generally be achieved through collecting payment from customers earlier or by pushing an extension of a payment with suppliers. Unforeseen expenses can also be seen as obligations and thus have to be taken into account in the approach toward working capital management as well.
Grow the business: With this, it is equally important to make effective use of short-term assets, either in providing global expansion or R&D investments. If the company’s asset is tied up in inventories or accounts payable, then the business is likely not maximized as much as possible. In other words, an overly conservative approach to managing working capital does not maximize as much as it should.
Maximization of capital efficiency: The second objective of working capital management is to maximize the capital utilization efficiency of funds—either by minimizing capital costs or maximizing capital returns. This is achieved through the former by recovering tied-up capital funds to minimize the need for borrowing, and the latter ensures that the return on investment of the spare capital exceeds the average cost of funding it.
Working capital requirements vary by industry.
Working Capital for Manufacturing Startups
For manufacturing start-ups, working capital management would be a balance of inventories and trade receivables. Manufacturing concerns generally keep large inventories of raw materials, work in progress, and finished goods. This will have to be effectively managed to prevent the carrying costs from becoming too high, such as storage, handling, and financing costs.
Conversely, manufacturers may sell their products on credit, giving rise to trade receivables. The management of trade receivables is essential to prevent them from becoming too old.
Implement a strong credit policy; and consequently, timely collections; and
Conduct intense credit checks on customers.
Inventories and trade receivables inventory need to be balanced to maximize working capital use.
Working Capital for Retail Startups
Retail startups face unique challenges due to their inventory-focused nature and cashflow dynamics. Retail businesses are inventory-centric and cash-flow-oriented with different needs for working capital. Unlike a standard manufacturing company, a retailer is more worried about an odd proportion of cash sales rather than depending on trade receivables. It mostly becomes important to keep cash reserves for the following reasons:
day-to-day operations;
Overhead cost; and
Unplanned expenses.
Inventory management is an integral part of working capital for retailers. It provides for adequate stock levels to meet demand without keeping too much stock. Variations in seasons add another complexity factor to inventory levels and need to be handled from a strategic perspective. Timely collection and optimization of the supplier’s credit period are some of the best practices of working capital management.
Working Capital Management for E-commerce Startups
E-commerce start-ups require working capital just like retailers are expected to, but on cash flow and the management of inventories. These businesses usually experience seasonal patterns. Demand is normally high in peak shopping times. Due to this, e-commerce start-ups have to account for these fluctuations so that they raise cash appropriately in reserve.
The management of e-commerce inventories is the perfect way to satisfy customer demand with minimal overheads of carrying inventory. Just-in-time inventory management is a very popular method, which enables startups to reduce storage costs and optimize their working capital. The e-commerce startups also have to implement order fulfillment and logistics.
strategies to reduce the lead times and optimize the cash flow. However, as the supply chain issues arising from the pandemic have proved, just-in-time inventory management can get you to a position where you run out of the goods you advertise. This leads to lost sales and damage to customer goodwill.
Conclusion
An important indicator of the company’s financial situation is the working capital requirement. Therefore, you have to calculate it regularly in order to understand the cash flow trends. With changing the suppliers’ deadlines and efficiently managing the stock, you can make a balance in WCR. However, if a business requires financing, then it takes a business loan to meet its working capital requirement. You might need a term loan calculator to calculate the loan amount you might qualify for, and the repayment term would be such that it offers EMIs that are cost-effective in terms of budget.