Working Capital, also known as net working capital (NWC), is the difference between a company’s current assets – such as cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods – and its current liabilities, such as accounts payable and debts.
Net working capital is important because it gives an idea of a business’s liquidity and whether the company has enough money to cover its short-term obligations. If the net working capital figure is zero or greater, the business is able to cover its current obligations, and this is where the working capital loan comes in.
Leveraging effective working capital management processes through each of these components can maximize cash flow, yield substantial returns, and reduce risks and costs.
There are a lot of advantages to using Net working capital for your small business. You can boost the business performance and remain free from the worry of running out of cash by learning to manage this component effectively.
Discussed as follows are ways in which you can accrue benefits from this financial aspect –
Ensuring Liquidity – Businesses often get in trouble due to the lack of cash needed for operations and to repay short-term debts. It happens because of an ineffective or no working capital management policy within the venture. Working capital management ensures liquidity by monitoring account receivables, account payable, stock management, and debt management.
Increases Profitability – Proper application of working capital management strategy would enhance the company’s profitability in the long run. The policy properly manages inventory so as to avoid any operational failures. Collection from trade receivables would be on time as receivables form a key part of working capital management. There would be no cases of default in paying the trade payable on the due date because of proper management and allocation of cash.
Avoids Interruptions in Operations – Working capital management involves the use of ratio analysis. Aspects like working capital ratio, quick ratio, accounts receivables turnover ratio, etc., are calculated and interpreted so as to provide information to management. Such information helps managers in planning and executing business operations in the most efficient way. Instances like delay in paying accounts payable, lack of production would minimize by a substantial amount. This would give the business an edge over its competitors.
Improves Financial Health – Basically, this aspect is concerned with the management of cash in an enterprise. It assesses the sources of cash inflows and determines the outflow of cash in the best possible manner. Proper allocation of cash makes a scope for the investment of remaining cash or in repaying short-term debts. It allows the business to be financially solvent most of the time and thus evading any legal troubles that could have arisen due to lack of funds. Higher profitability would imply a higher return on capital employed. This, in turn, would attract more capital from prospective investors leading to the unlocking of further capacities.
Value Addition – As mentioned earlier, working capital enhances a company’s financial health and operational success. It makes the company stand out amongst its peers. A sense of respect emerges in the market for the business. This, in turn, leads to value addition for the entity.
Some aspects that benefit from working capital loan include –
- Retained earnings;
- Increase in sales paid in cash;
- Reduction of deadlines for receipt;
- Increased availabilities;
- Decrease in taxes to be collected and in the balance of accounts payable;
- Extension of payment terms;
Therefore, net working capital is important because it gives an idea of a business’s liquidity and whether the company has enough money to cover its short-term obligations. If the net working capital figure is zero or greater, the business is financially healthy and making good progress.
Through a working capital loan, you can provide the venture with an edge that would enable it to not just survive in an competitive environment, but also thrive financially going ahead.