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Making Sense of Working Capital Management

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(Credit: Pexels) Making Sense of Working Capital Management
January 7
5:30 PM 2020

The first goal of any business should be to generate enough revenue to cover its costs. The second objective is to have a profit left over. If a business reaches this point, it's considered a success. However, what a business does with the money coming in - and how it balances that against the money going out - is the ultimate decider of whether or not it can be considered a thriving enterprise.

This is where working capital management comes into play. Also known as working capital optimization, this process makes the most of the assets of a company when weighed against its liabilities. Simply put, working capital management utilizes the value of mostly static in order to increase the available cash-on-hand, which is the dynamic capital used to cover the costs of doing business on a day-to-day basis.

For owners and operators of small businesses, whose main focus is on providing goods or services to their customers, the concept of working capital management can be a little confusing. After all, not every business owner is well-versed in finance, nor should they feel compelled to become financial experts. But that doesn't mean they should ignore the benefits of optimizing their working capital.

One of the biggest advantages of working capital management involves the optimization of the accounts receivable collection process. As most business owners know, the timetable for a customer's ability to pay varies from one account to another. Making every customer adhere to the same payment schedule and due dates can negatively affect the bottom line, in that customers are under pressure to modify their own financial situation and may subsequently fail to pay what they owe.

When businesses opt for working capital management, they give customers more flexibility to pay without negatively affecting their own cash flow. This typically involves the successful identification of those who are most able to pay and zeroing in on those accounts first. While slower to pay customers still need to be addressed, your company benefits from prioritizing accounts in a way that keeps money flowing in faster than it's going out.

Another advantage of working capital management involves the optimization of inventory cycles. Determining which items to order at what time can prevent overstock and stock-out situations. This frees up more cash to be used to cover expenses, reduces the costs associated with having more stock than you need, and prevents the lost sales when items are out of stock.

Many businesses are owed money by customers while simultaneously owing money to their own suppliers. Similar to how it helps sort out and prioritize accounts receivable, working capital optimization helps businesses to determine which suppliers they can negotiate with when it comes to making payments. Once again, this helps to free up the capital needed to cover additional costs of doing business.

All in all, working capital management is a process meant to make the most of a company's assets in order to better cover the costs of day-to-day operation. While many transactions can be adjusted, others cannot, and it's these unmovable expenses which demand the lion's share of a company's cash-on-hand. By making adjustments when possible, businesses optimize their available capital, ultimately enhancing their ability to conduct business in the most cost-effective way possible.

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