As a small business owner, effectively managing your working capital is crucial for your company's success, both now and in the future. However, this is often easier said than done. Robust growth, fluctuating sales cycles, and increased operational expenses can strain your cash flow and make it difficult to manage working capital effectively. This Huddle Business Capital blog article features some best practices regarding working capital management.
What is working capital?
Before discussing working capital management, we want to provide an overview of working capital. Simply put, working capital refers to the funds available to cover your day-to-day operational expenses and ensure smooth business operations. Similar to cash flow, working capital is a measure of your business's financial health.
Working capital is required at every business stage, from initial startup to growth to maturity. Having adequate working capital enables businesses to pay suppliers, manage inventory levels, meet payroll obligations, and handle unexpected expenses or fluctuations in demand. In addition, it acts as a safety net during times of economic uncertainty or market volatility.
How to calculate working capital.
Calculating your business's working capital is straightforward so long as your balance sheet is updated and accurate. All you need to do is subtract your current liabilities (e.g., accounts payable, employee wages) from your current assets (e.g., cash, accounts receivable), both of which are on your balance sheet.
Let us say a small business has $500,000 in current assets and $350,000 in current liabilities. In this example, the company has positive working capital totaling $150,000 ($500,000 in current assets minus $350,000 in current liabilities = $150,000). Positive working capital enables the business to cover the cost of its short-term obligations, such as employee payroll, office rent, and suppliers. Conversely, negative working capital would indicate potential financial strain and difficulties meeting financial commitments.
Now it's time time to discuss ways to manage working capital. Remember that every business owner's situation is unique, but these are best practices used by businesses in all industries nationwide.
1. Increase inventory turnover.
Efficient inventory management is crucial in effectively managing working capital. Businesses can optimize their operations, reduce costs, and improve cash flow by implementing various inventory management techniques. If your company has inventory, avoid overstocking goods and items that are slow-moving and might end up sitting on shelves. It is better to purchase stock that sells quickly in a short period, generating revenue and freeing up your cash flow.
2. Avoid unnecessary spending.
Wasteful spending and unnecessary costs can eat into profits, hinder growth, and even jeopardize the long-term sustainability of a small business. To ensure financial stability and optimize your working capital, you should evaluate your expenses and make necessary changes. Following are some strategies to consider.
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Evaluate recurring expenses and subscriptions
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Streamline procurement processes to avoid overspending
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Implement energy-saving measures to reduce utility bills
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Avoid unnecessary travel expenses through remote work options or video conferencing tools
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Reduce or eliminate non-essential expenses that do not contribute to your business's core operations
3. Streamline collections.
Your business relies on a steady cash flow to meet its financial obligations and support day-to-day operations. Effective management of accounts receivable can help you maintain healthy working capital levels. Managing your receivables efficiently ensures that invoices are promptly issued, payment terms are clearly communicated, and collections are diligently pursued. This can minimize the risk of late or non-payment and optimize your business's cash flow and working capital.
4. Negotiate with vendors.
It is common for vendors and suppliers to offer their customers preferential prices and payment terms to keep their business and prevent them from going to a competitor. But you must contact them for this to happen; otherwise, the prices and terms will likely remain the same. By fostering your relationships with vendors and suppliers, you might be able to negotiate favorable prices and payment terms that align with your cash flow requirements. This, in turn, can positively affect your working capital.
5. Obtain a working capital loan.
Managing working capital can be challenging, no matter how diligent you are and how many best practices you follow. This is where working capital loans come into play. This option gives your business the necessary funds to bridge the gap between its current assets and liabilities. Working capital loans can be used to cover operational expenses such as inventory, payroll, rent, utilities, and marketing campaigns. By accessing much-needed funds through a working capital loan, you can ensure that your daily operations continue uninterrupted while you focus on driving growth.
Disclaimer.
This Huddle Business Capital blog article is purely educational and contains general information and opinions; it is not intended to provide advice or recommendations of any kind.
