Question

Why business manage working capital?

How can a business increase its WC?

How can a business decrease its WC?

Answer 1

1.Proper management of working capital is essential to a company’s fundamental financial health and operational success as a business. A hallmark of good business management is the ability to utilize working capital management to maintain a solid balance between growth, profitability and liquidity.

A business uses working capital in its daily operations; working capital is the difference between a business's current assets and current liabilities or debts. Working capital serves as a metric for how efficiently a company is operating and how financially stable it is in the short-term. The working capital ratio, which divides current assets by current liabilities, indicates whether a company has adequate cash flow to cover short-term debts and expenses.

Working capital management is essentially an accounting strategy with a focus on the maintenance of a sufficient balance between a company’s current assets and liabilities. An effective working capital management system helps businesses not only cover their financial obligations but also boost their earnings.

Managing working capital means managing inventories, cash, accounts payable and accounts receivable. An efficient working capital management system often uses key performance ratios, such as the working capital ratio, the inventory turnover ratio and the collection ratio, to help identify areas that require focus in order to maintain liquidity and profitability.

2.Working capital can be increased by 1) earning profits, 2) issuing common stock or preferred stock for cash, 3) replacing short-term debt with long-term debt, 4) selling long-term assets for cash, 5) settling short-term debts for less than the stated amounts, and 6) collecting more of the accounts receivables than was anticipated and then reducing the balance required in the current asset account Allowance for Doubtful Accounts.

3.To unlock capital tied up in your inventory, you need:

1. Supplier payment terms that are longer than the payment terms of the customer
2. Inventory turnover that is faster than the payment term difference

The best starting point is to find out the stock level that really supports your business at minimal cash out. Only afterwards you might consider extending an order and receive a supplier discount, because now you are aware of the extra cash required to get this discount. With this preparation you are in the position to reduce the working capital and improve your cash flow. That way, you can put yourself in a better position to control your spending - get discounts or expand the business.