The main purpose of this article is to walk you through working capital management and the fundamental ideas involved in the calculation of the average capital generated by a company that can be set aside to invest in the day-to-day business processes. This calculation is performed in the context of the total assets accumulated by the business over the period of one working day tallied against the many liabilities that the business may be chargeable with.
The term current asset is used to describe anything that can be quickly changed into cash within a period of one year. These assets are predominantly found in the form of the most liquidated assets held by the business. Short-term investments, inventory contents, receivable accounts, and hard cash are some of the most common examples of current assets.
Likewise, any commitment that the business is obligated to acknowledge within a period of one year is considered a current liability. Receipts for the expenses of business operation and the current components of long-term debt payment plans are examples of this. The figure of difference between the current assets and the current liabilities denotes the total amount of capital that is available for use in the day-to-day operations of the business.
The difference obtained can either be a positive integer or a negative integer.
Features of Working Capital
- If the difference is found to be a positive integer, it is a favorable sign for the business. This would mean that the assets available to the business operatives are greater than the liabilities that the business operatives have to manage. In this scenario, it is possible for the business operatives to redirect some of the available funds to invest in making the quality of production better in the concerned business entity. The funds can also be used to increase the quality of work equipment, working environment, or the salary of the workers and the business operatives.
- On the other hand, if the working capital is found to be negative, this would imply that the business has been weighed down by an excessive amount of burden from debts, losses, and so on. In such a scenario, it is advised for the business operatives to take certain steps and measures to make sure that the daily assets available to the business increase and the liabilities decrease, thereby giving rise to a positive Working Capital. These steps can include increasing the total working hours to boost the rate and degree of production, advertising in a more efficient manner to draw in more customers, and preventing extra expenses by cutting down on unnecessary services and commodities or by letting go of unproductive workers.
- In a nutshell, the greater the working capital, the greater the profitability of the business operation, and vice versa.
In the fiscal year between 2019 and 2020, a study was conducted by PwC, one of the four most influential business firms in the world. The aim of this study was to observe the trends observed in the sphere of working capital in the corporate world over the course of the last five years. The findings of this study indicated that:
- On average, eight out of every eighteen industries showed a growth in the available day-to-day capital.
- Between 2017 and 2018, the global capital showed a 9.4 percent hike, which stands for an amount of 360 billion Euros.
- On the basis of day-to-day performances, however, the capital was only observed to increase around the equivalent performance of 0.1 days.
Working Capital Management
The term working capital management is used to define the several strategies that are involved in regulating the daily assets and liabilities in a business operation and making sure that the day-to-day figure of current capital is favorable for the smooth and profitable operation of the business.
Features of Working Capital Management
The key features of working capital management include:
- The strategies of working capital management commonly include methods to analyze the key findings from the current capital. This analysis can help a business operative acquire the significant ratios of their business capital. These ratios include the working capital ratio, the collection ratio, the inventory turnover ratio, and so on. These ratios can further help indicate the significant figures in the operation of the business, such as current assets, current liabilities, and cash flow.
- Most business operations are run using a net operating cycle. This formula is also referred to as the cash conversion cycle (CCC) since it is used to define the minimum duration of time that is required to convert the day-to-day assets and the day-to-day liabilities of a business operation into liquidated assets or cash. Working capital management also involves the formulation of strategies that can help make sure the cycle operates in a smooth and frictionless manner. These strategies are also used to minimize the time taken for the process of conversion.
- The strategies involved in this process are not just supposed to ensure that there are sufficient funds for the operation of business on a given day. These strategies also help reduce the cost of business operations. These strategies help minimize the liabilities involved in the day-to-day operations of the business entity by cutting down on unnecessary investments. This helps the businesses acquire a substantial amount of Return on Investment.
Importance of Working Capital Management
The most important utility of the strategies involved in managing the day-to-day capital generated by a business is to come up with ideas that can help a business operative maintain a level of cash influx that is necessary for the operation of the concerned business. This daily generation of capital should be sufficient enough to meet the cost of business operations on any given day as well as to be able to pay off the debt obligations on any given day. These strategies are primarily formulated on a short-term basis.
In layman’s terms, the working capital of a business operation on any given day can be expressed as the difference between the total assets that have been procured by the business on that day and the total amount of liabilities that are impacting the business operations on the same day.
The steps taken by a business operative to make sure that the day-to-day working capital of their business entity is favorable for the cost of operations can be referred to as working capital management. If you are an up-and-coming business owner or an entrepreneur, this article will help you get familiar with two of the most important concepts in shaping the finance model of your business venture.
In case you are engaged in a business enterprise where the daily liabilities exceed the assets and the cash-in-hand, this article will introduce you to certain basic strategies that are commonly used by business operatives to manage their working capital.
If you require any further assistance, feel free to contact business coaches and mentors at MSMEx.in
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