What is Working Capital Management?
Working capital management is a corporate strategy that is implemented to allow efficient supervision and usage of a company’s assets and responsibilities to the optimum level. Effective management of working capital proves crucial for the financial health of a business. Hence, the success of launching and maintaining business operations also depends on working capital management. How else can this specific strategy impact a business?
A corporation utilizes working capital in immediate daily tasks. Also, the short-term financial stability depends on the working capital. The operations of an organization flow smoothly with adequate cash flow. In order to recognize the available working capital to generate cash flow, the working capital ratio can be used. This is obtained by dividing the current assets of the company by current liabilities.
Three principles to take away about working capital are given below,
- Working capital management targets optimizing the operations of an organization.
- The profits earned by the company can increase with proper working capital management.
- This process includes the management of inventory, accounts, and accounts payable.
The Importance of Prioritizing Working Capital Management
Working capital is an absolute necessity for a business, as it needs a constant supply of cash to make regular payments and purchase production material. Furthermore, working capital management can ensure smooth sailing of the required cash flow and enable increased profitability and short-term goal reach.
The main goals of working capital management include,
- Balancing work capital operating cycle
- Handling targeted operations
- Limiting the capital expenditure on working capital
- Maximizing the return on asset investments
To properly understand the importance of working capital, consider a person’s cost of living. People collect the money that is owed to them, collecting money to maintain daily expenses, pay bills, and other immediate expenditures. Therefore, similar to managing daily living costs, working capital and working capital management bring about liquidity, efficiency, and healthy growth of an organization.
The needs for working capital and its magnitude vary from organization to organization. This situation likely arises due to the following conditions.
- Differences in collection policies
- Differences in payment policies
- Timing asset purchases
- Generating cash flow from accounts receivable
- Projects for raising capital
Working capital management allows an organization to efficiently manage cash, inventories, accounts receivable, and accounts payable. Hence in the process of implementing this strategy, an organization can detect the areas that need focus to improve profitability and liquidity.
The Impacts of Working Capital on Cash Flow
Changes made in working capital are reflected in a company’s cash flow. However, if a certain transaction increases both the current assets and liabilities of an organization, there would be no change in the working capital. In a situation where this balance is not maintained, the change is reflected in the cash flow statement due to a change in working capital.
Examples for a few such situations are given below,
- Purchasing fixed assets can decrease the cash flow. If a company purchases a building, its working capital would decrease due to the reduction in cash in current assets. However, the current liabilities remain the same, as purchasing a fixed asset would result in long-term debt.
- In a situation where the same company sells a fixed asset, its cash flow would get a boost. This also results in an increase in working capital.
An organization’s working capital and working capital management prove crucial for generating cash flow and utilizing current assets to fund short-term operations. It is essential to monitor the status of our working capital through working capital management. Therefore, this allows the organization to increase its profits and ensure smooth sailing of the company operations,
For more information about working capital, visit our KnowedgeHub
https://fundo.id/knowledgehub/en/how-working-capital-functions-your-guidance-manual-to-understanding-working-capital/
