Question

In 200 words or more, Discuss how a person or business can manage working capital

Answer 1

By formula, working capital is excess of current assets held by the business over current liabilities owed by the business, that is:

Working Capital = Current Assets - Current Liabilities

By definition, working capital are the capital resources used by the business to run and manage its daily operations. Every business needs to effectively manage its day to day capital resources and can do so in the following manner: (67)

1. Payment to suppliers

Sometimes suppliers provide discount for early payments, hence, it is necessary to evaluate the discount received from early payments to suppliers versus the advantages of paying suppliers at the end of the provided credit period. Days payables outstanding should be maintained at optimum levels in order to ensure higher availability of cash flow in business. Also, it is most prudent to have days payables outstanding in line with days sales outstanding to ensure smooth cash flows. Effective negotiating for payable days with suppliers is very necessary.

2. Manage days sales outstanding

One of the most efficient ways to manage working capital cycle is to keep a check on the number of days that sales contract remaining outstanding for the business. This means understanding the number of days for which a customer utilises the credit facilities offered by the business and ensuring that recovery of payment is done on time from the customer. Shorter the days sales outstanding, better is the working capital management. Days sales outstanding can also be better managed by providing discounts to receive cash inflows quickly for higher effective WC management.

3. Inventory management

It is important to compute the number of days it take to convert the raw materials to finished goods. The higher the number of days required for this conversion, more delayed shall the payments to be received from customers. Hence, it is necessary to manage inventory conversion days to manage working capital.

4. Bank facilities

Effective working capital management also requires ensuring emergency cash resources/loans available with one or more partner bank. It is necessary that such funds can be received within a short period (24 - 48 hours) period in order to effectively manage payments.