It is true that businesses survive on profits, and without it, ensuring smooth day-to-day operations becomes a herculean task. To ensure these profits, a business needs a healthy working capital flow, regardless of their size. It is the most important metric to measure growth, as it signifies their operating liquidity.
Therefore, let us understand what working capital really is and how it helps your business thrive.
What is Working Capital? Why do you Need it?
Working capital is also known as net working capital and it is the difference between the company's current assets and current liabilities. It measures the company's liquidity position, operational efficiency and short-term financial health.
It is calculated by using the current assets and current liabilities available within the 12 months. If the company has a positive working capital ratio (more than 1), then it signifies its potential to grow and invest. Whereas, a negative working capital ratio, or less than 1, indicates trouble in the company and difficulty in meeting short-term obligations.
A company with negative working capital may find it difficult to secure new sources of finance. Additionally, we should note that high working capital is undesirable for businesses. As it indicates inefficiency on part of the management in deploying capital or keeping excess inventory.
5 Ways a Healthy Working Capital Flow Can Boost Your Business
Maintain Cash Flow
One of the key objectives of having a healthy working capital flow is to maintain sufficient cash flow. It helps the business meet its operational expenses and short-term debt obligations. This enables businesses to achieve greater operational efficiency and undertake new investments for growth.
By analysis of working capital and cash flow, one can easily determine the financial viability of the business. Also, in the long term, improved cash flow position results in an increase in working capital.
Maintain Optimum Levels of Inventory
A healthy working capital enables businesses to maintain an optimum level of stocks or purchase additional inventory to meet the demand.
It also helps to negotiate better pricing on bulk purchases where upfront payment is required for an order. Thus, it allows you to maintain your competitiveness in the market and drive up sales and customer satisfaction.
Meet Day-to-Day Expenses
Positive working capital supports a business's day-to-day operational costs. It can be used to hire new employees, launch marketing campaigns, and lease additional space for expansion or to renovate the workspace.
At times, it also helps you bridge the gap when there are delays in collection of account receivables or delay in insurance reimbursement for damaged goods.
Upgrade Equipment
With healthy levels of working capital, you can easily undertake work on upgrading your equipment, which is important to ensure smooth business operations. Working capital helps cover the cost of upgrades, without any impact on the cash flow situation of the business.
Using working capital to fund equipment up-gradation cost translates to higher long-term benefits such as an increase in working capital cash flow.
Cover Unexpected Expenses
There are many costs a business establishment needs to incur, which are not planned and are totally unexpected. For example, costs incurred to repair machinery, damages due to natural calamity or a sudden shift in market demand.
A healthy working capital level provides businesses with the required flexibility to cover unexpected expenses and deal with liquidity problems. It also helps to respond to the change in market demands to stay relevant in the market.
Irrespective of the size of your business enterprise, you always need an efficient working capital management strategy. This part of the capital helps you to increase your wealth. In other words, its proper management results in the improved fundamental health and operational success of the company.
A business with a positive working capital is better placed to take advantage of new business opportunities and respond to market changes. Thus, a healthy working capital ensures a balance between liquidity, profitability and growth in business.
