Working capital refers to the operating liquidity available to a business or company to fund their daily operations. In a company, the working capital is the amount of cash they have available to run the daily operational needs of the business. Working capital is directly related to the financial well-being of a company. Managing it effectively is the key to running a business successfully.
There are various day-to-day costs involved in running a business successfully, ranging from electricity bills to overhead expenses and beyond.
Working capital cycle (WCC) is the amount of time taken by a company to convert its net current assets as well as liabilities into cash. The life cycle of working capital is directly tied to the fortune of a business.
The WCC depends on a lot of factors, the major among which is the business’ stage of development. Typically, companies in their initial growth phase have a longer WCC as investments need more time to bear fruit.
A longer WCC indicates that the company is binding too much of its cash to the working capital and not generating returns with it. As such, every company attempts to attain a short WCC and enhance its liquidity in the short-term.
Factors Affecting a Company’s WCC
More than anything else, a business’ working capital cycle is connected to the stage of development it is in. Some factors that may lead to a longer WCC include:
- The WCC is usually longer when a business is in its initial stages of production. There are various costs involved to start a business, and it usually takes a fair amount of time to get it on its feet.
- The same can be said about expansions. It involves a multitude of costs, and it may take a considerable amount of time before you get returns out of it.
- Growth opportunities also come with their fair share expenses. A new business opportunity needs funding in the form of stocking inventory, spending on product development and market research. You may not get immediate returns for these expenses as well.
Many companies resort to business loans to inject more cash into their business and bring the WCC back on track. Multiple NBFCs like Bajaj Finserv offer such loans which a company may use to increase all kinds of working capital.
A Beginner’s Guide to WCC Management
Working capital management is a vital cog in the operation of any business. Every company, regardless of its size, profit or stage of development, should have a clear roadmap of working capital management to maximise sustainability and profitability.
Here are a few ways in which a business may shorten its working capital cycle and increase immediate liquidity.
1- Accurate Inventory Management
One of the primary challenges that many businesses face is inventory management. They either have too much or too little in their stock, both of which are inherently harmful to business growth.
It is necessary to strike a balance between the two and manage one’s inventory efficiently to reduce the WCC.
2- Seek Early Payment
WCC management begins with incoming cash flow from delivered orders. Many companies receive payments months after they have delivered the orders. It elongates the working capital cycle and restricts cash flowing into the business.
It is best to make arrangements so that payments are made as early as possible. Such measures will also help inject your business with enough funds to enhance smooth operations.
3- Offer Cash-Only Deals
No business can thrive in today’s economic atmosphere if it remains a cash-only venture. You may have to offer goods on credit and cheques. However, discounts on cash only transactions may influence customers to purchase your products with cash, thereby enhancing your working capital cycle.
Understanding WCC and Reinvestment Together
There is another approach that many enterprises continue to adapt in recent times regarding their WCC- reinvestment. Businesses are increasingly redeploying their resources back into the business to drive home greater value additions.
The key to successfully reinvest begins with integration of a value framework to the organisation’s identity. Many people are of the notion that increasing working capital can have negative implications for a company’s growth story. A clear and precise framework which offers a holistic view of the organisations future aspirations and key decisions required to achieve those aspirations.
This framework may also highlight certain trade-offs which cannot be measured in the usual financial metrics, such as reputation risk. You may clearly demarcate the point at which the lack of working capital and subsequent increasing payment terms harms your company’s reputation and brand identity.
Reinvesting can solve many such problems without putting any additional burden on your company’s finances.
Working capital management is the cornerstone of success for any business. One must take appropriate measures to keep the cycle as short as possible or risk the shortage of funds for business operations.