With proper working capital management, small business owners can ensure the smooth running of all daily operations. Often small-scale business owners find it difficult to meet their daily business expenses due to insufficient funds. This is when working capital loans come into the picture.
Apart from just managing one’s daily business expenses, working capital can prove beneficial in several other ways. Let’s find out!
How can working capital be useful for a small business?
Before knowing how much working capital your business requires, know the benefits of a working capital loan:
- Meet short-term expenses working
A working capital loan facilitates short-term financial expenses. Small businesses need liquid assets to purchase materials, equipment, paying utility bills and more. Having a considerate amount of liquidity helps flow of production. Hence, it ensures the solvency of business for a longer time.
- Predict cash flow
Based on receivables and payables, small businesses can predict the future cash flow. A good prediction can save a company in case of a financial crisis in the future, and the surplus amount can encourage growth.
Better cash flow retains an uninterrupted supply of raw materials. Hence, a company can promptly meet its regular expenses.
- Improve ability to face any financial crisis
Besides smooth functioning of cash flow, working capital helps to ease any financial crisis. Therefore, companies with proper cash flows can shield themselves from any future financial circumstances.
What is working capital?
Also known as Net Working Capital (NWC), working capital is the difference between a company’s current assets and current liabilities. It is the measurement of a company’s short-term financial health. Current assets are liquid assets (cash), account receivable, raw materials and equipment inventory, cash equivalent, marketable securities, etc. Current liabilities are account payables, wages, accrued liabilities and short-term debt.
To calculate working capital for your business, business owners can use this formula-
Working Capital = Company’s current assets – company’s current liabilities
Positive Working Capital means the ability of the company to fund its on-going operations and invest in future projects and growth. However, maintaining a positive NWC is one factor that increases the chances of getting business loans quickly.
Apart from the above-mentioned benefits, working capital helps in the proper use of fixed assets, renders goodwill of the company.
What is the need for working capital management?
A working capital management is an essential part of maintaining a healthy business operation. Proper management includes knowing the basic components like:
- Account receivable
Account receivable is the customer’s unpaid bills. It is the balance money that a company will receive from its customers for past services or products within a period or fiscal year. It is listed on the balance sheet of the current asset.
Simply put, this is the total amount customers owe to a company for any purchase on credit. When a company lets a customer purchase on credit, it takes IOU (I owe you) documents from the customer. AR helps to understand how much surplus asset a company can have which can be encashed.
- Account payable
Account payable is somewhat same as account receivable. The main difference is that the company owes money from distributors or other enterprises for services like purchasing raw materials, etc.
To understand it clearly, take the example of company A sends heavy machinery to company B. So company B owes money to company A. Hence company B will keep records of the invoice from company A in its accounts payables. Account payable aids in understanding how much debt a company has to pay. Based on that, a company can decide how much working capital loan it can avail.
- Inventory
It is the accounting of purchased raw materials, equipment etc. It helps to understand the company’s operationality.
- Cash and cash equivalent
Cash equivalents are bank accounts and marketable securities which can turn to be cashed. Cash and cash equivalent help to pay off current liabilities.
Apart from subtracting current assets from current liabilities, effective capital management is done using the cash conversion cycle (CCC).
Where,
Cash conversion cycle = Days inventory outstanding (DIO) + Days sales outstanding (DSO) – Days payables outstanding (DPO)
CCC- is the average time taken by a company to convert the investment inventory into cash
DIO- is the average number of days to sell inventory for a company
DPO- is the average number of days for a company to pay suppliers
DSO- is the average number of days for a company’s customers to pay invoices
The lesser the number of CCC of a company, the better the company’s cash flow into its inventory.
The objective of effective NWC management is to minimise the capital spending cost and maximise the current asset investment. Thus, by managing it properly, companies can smooth the capital operation.
Business owners falling short of funds to run daily business operations can opt for business loans as an alternative from leading NBFCs like Bajaj Finserv. It also provides pre-approved offers to further streamline the loan application process. These offers are also applicable to a number of financial products like business loans, personal loans etc. Potential applicants can now check their pre-approved offers by entering their names and contact details. Working Capital maintenance can save entrepreneurs from a financial crisis. Moreover, it may help business owners pay off short-term debts and provide business protection from unforeseen short-term financial emergencies.