While the concept of working capital management has been around for a long time, its importance gained prominence, particularly during the pandemic.
Due to the extended lockdown, business ventures have had to rely on a working capital loan to minimize financial liabilities. Disrupted supply chains and delays in receivables are some of the leading reasons why ventures have been facing low levels of working capital, and this is where loans come in. However, availing of a loan also necessitates efficient management of the working capital so as to be able to accrue maximum benefits.
Some ways in which ventures benefit from good working capital management include sufficient liquidity, which in turn provides flexibility in daily operations, and an increase in profits courtesy of overall financial vigilance. However, in order to reach this stage, the following are some tips that you must incorporate in the context of handling working capital –
Pick appropriate working capital metrics
Paying attention to working capital metrics on a monthly and quarterly basis has been found to have a significant bearing on the venture’s overall financial health and performance. Metrics that take priority over others are a debt to equity ratio, turnover of account receivables and benchmarks associated with cash flow. Over the long term, entrepreneurs must also keep track of inventory and outstanding payables.
Improve upon inventory turnover – Aspects of the venture that benefit from good inventory management are account receivables and payables and daily operations. Since the objective is to reduce slow-moving inventory and avoid stockpiling, the venture must order only as much inventory as required for production and sales instead of overstocking.
Strive to be paperless
Shifting to electronic transactions is the first step towards a paperless system, and in addition to augmenting efficiency, it also enables saving on overheads. An automated system enables entrepreneurs to streamline payables versus receivables and optimize cash conversion cycles. When the venture uses an automated system to deliver invoices, the probability of errors and chances of invoices getting lost is significantly reduced.
Ensure continuity of funds
Applying for a working capital loan and utilizing the funds is one of the smartest ways to ensure that an optimal level of cash is available. The trick lies in analysing the working capital needs of the venture and accordingly identifying an appropriate financial solution that would ensure liquidity in keeping with the forecast. There is also the option of alternative lenders, who provide a working capital loan if the business plan is sufficiently convincing.
Comprehend financial jargon
It is imperative for entrepreneurs to comprehend the financial jargon to avoid confusion and misunderstanding in the future. For example, a common point of confusion is whether the terms cash flow and profit mean the same. The two are actually totally different entities wherein cash flow refers to the incoming and outgoing money. Profit is the amount that the entrepreneur is left with after adding up the sales receipts and having incurred all the expenditures. Both aspects need to be monitored closely and handled with vigilance to avoid long-term problems.
Do bear in mind that managing the working capital of the venture is a responsibility that everyone needs to share, rather than just the financial team bearing the burden. While the specialist at hand might be totally focused on this aspect, other players in the venture must also play their part to ensure that the financial targets are duly met, particularly if there is a working capital loan involved.
Ideally, the working capital should not be too high or too low at any given point. Efforts should be dedicated to maintaining an optimal level through management best practices and financial efficiency.