An Introduction to Working Capital Management

Published on
July 14, 2020
Written by
Alvin Ip
Reviewed by
Episode #
An Introduction to Working Capital Management
An introduction to understand what a working capital management is, what the objectives are, importance and techniques for an effective working capital management.
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As the name suggests, working capital management refers to the efforts of managing your working capital. It's an important indicator of a company's financial health and success as a business. Working capital itself refers to the company's current assets and current liabilities or debts. In other words, a good working capital management determines the growth, profitability and liquidity of the company.

Objectives of Working Capital Management

Objectives of Working Capital Management

The main goal of working capital management is to ensure that the company is able to continue operating. Along with that, able to satisfy the short-term debt and upcoming operational expenses. Some other objectives of working capital management are:

1. Working capital balance: Calculated from the ratio of working capital management, current assets divided by current liabilities. The lower the value of this ratio, the more it shows that the company is financially unstable to clear its debts. However, if the value is higher, it suggests that the company may have too many inventories that are not in cash.

2. Avoid over-borrowing: In general, loans from banks or family members are considered an additional cost that you must repay, which may include interest depending on the arrangement. If your margins show that you cannot afford to borrow money, it's best to scratch that idea altogether.

3. Optimize working capital cycle: This cycle includes production, collecting raw materials and other initial investments, selling goods as soon as possible, and collecting receivables on time.

4. Maximize current asset investment's return: Aim to obtain the maximum investment in current assets to ensure higher profitability for your business

5. Maintain good relations with suppliers: It is more likely for the lenders, suppliers, providers, also non-trade creditors to be more interested in doing a business with you when you have a defined working capital management

Importance of Working Capital Management

Importance of Working Capital Management

Working capital management is important due to the following reasons:

• Improve company's credit profile — Well-managed working capital is more likely to pay off the debts on time, which results in a higher credit score for the company

• Ability to Face Crises — Proper working capital management equips businesses during times of crises including economic downturns

• Expansion — If there is adequate management of working capital, the additional capital accumulated can be utilised for business expansion

Working Capital Management Techniques

Working Capital Management Techniques

1. Manage inventory and procurement

Over-stocking can be a burden on the business' cash. Contrarily, insufficient stock can result in damage to customer relationships and loss of sales. The challenge for companies is to establish optimum stock levels. Hence, it is important to control what you purchase for your company.

2. Improve receivable process

This can be done by sending out invoices as soon as possible. Reassess invoicing process that may be causing delays in sending the invoice to your debtors such as manual processing, lost invoices, and so on.

3. Manage debtors effectively

Besides sending out invoices on time, it is important to be receiving payments on time. Reassessing your contracts and credit terms with debtors may be necessary to make sure you're not giving debtors such a huge a window to pay for goods and services as this may be impacting negatively on your own company’s cash flow.

4. Pay vendors on time

Companies that pay on time tend to develop a better relationship with their suppliers and have higher chances to negotiate better deals, payment terms and discounts. If you keep your suppliers happy, it could save you money in the long run when it comes to getting larger discounts of bulk buying, maximizing the credit period, and recurring orders.

How can working capital management affect my business?

Working capital management requires great attention and care due to the interactions between its components. In terms of managing inventories, cash flow, and accounts receivable and payable, it contributes to whether the company is able to be successful in the long run in terms of managing inventories,

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Alvin Ip is a finance leader. He masters business strategy, fund raising, business intelligence, corporate finance and scaling finance teams for growth. He has been a CFO & CEO for multiple businesses and has worked with brands like Varde Patners, PwC Singapore, EY France & more. In his free time, he shares his experience & expertise to help businesses learn and grow.
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