Regardless of the company’s size, working capital is identified as an appropriate indicator to assess the company’s financial health and overall well-being.
Working capital of a business is a very straightforward calculation of subtracting Current Liabilities from Current Assets but has several implications. Current Assets include cash, cash equivalents, advances, and accounts receivables, whereas Current Liabilities include short-term debts, accounts payable, and obligations due in a year. Substantial working capital reserves are a reflection of operational and financial stability that demonstrates tremendous growth potential.
Given the economic uncertainties resulting from the global outbreak of coronavirus, businesses are grappling with an acute financial crunch to keep their operations going. To survive to tell the tale, companies need to focus on optimizing their working capital to maintain adequate liquidity that meets short-term commitments.
Here are the ways to manage working capital efficiently in 2021:
Inventory Management
Effective Inventory management is an essential factor to manage the working capital efficiently. Bulk orders will pile up stocks, adding pressure to the overburdened cash reserves of the company. Additionally, excess inventory comes with inventory handling costs and insurance costs.
On the other hand, the insufficient stock will lead to missed sales opportunities and impact revenue, further dampening cashflows and customer relations.
It’s essential to keep a tight check on the demand and sales and determine the re-order levels to avoid additional costs on physical storage, insurance, or wastage of perishable products. Periodic inventory checks help monitor the possibility of understocking or overstocking and to take preventive measures.
You can also reduce the inventory cost by utilizing the Just-in-Time technique, wherein you can order as and when required and reduce the carrying cost of the inventory.
Pay suppliers on time
Counterintuitive as this may sound, it is crucial to ensure timely payment to suppliers in these times. Small businesses across industries are impacted, which means your supplier is facing the brunt of this crisis, as much, if not more.
Timely supplier payments in good and bad times can help build stronger relationships based on trust and mutual respect. Companies making timely payments to vendors can develop long-lasting relationships and place themselves in a better position to negotiate better pricing, comfortable payment terms, and improved support in the end.
While delaying supplier payments might give you some breathing room in current times, it is not a good practice over time as suppliers might lose trust and choose to sell to other customers with better payment terms.
If you do not have surplus working capital to support this, reach out to financiers like Tata Capital that offer supply chain financing solutions. Supply Chain Financing can be structured to help you and your suppliers optimize working capital.
Timely inflows of cash will help optimize working capital. It is vital to reassess your contracts and credit terms with debtors to identify that the receivables collection period is not beyond the prescribed norm. Extended collection periods will negatively impact the company’s cash flows.
Keep an appropriate check on the credit terms and implement effective control procedures to avoid bad debts.
Upgrade receivables management
There is a dire need to fasten the billing and collection process. Companies should reassess the invoicing process and rule out the inefficacies of the existing system, which may include manual processing, lost invoices, and a high volume of invoices or errors to manage.
Automating receivables management with the right technology solution to send invoices electronically, speed up the billing and collection turnaround can eventually shorten the cash conversion cycle.
It is imperative to maintain a good current ratio. The current ratio is nothing but Current Assets over Current Liabilities. This ratio should not be overlooked because it determines whether your business has enough short-term assets to pay off the short-term debts.
A current ratio of 1.0 or less than that indicates that your working capital reserves are stretched and overburdened. This situation could arise from delayed payments from customers or unexpected expenses increasing current liabilities.
A current ratio of 2.0 or higher indicates that you are not making effective use of your resources. In this scenario, you should look for new investment opportunities and reinvest surplus cash reserves to earn better returns.
Conclusion
As economic uncertainty continues in 2021, businesses must look for new ways to optimize working capital and ensure business continuity. By focusing on inventory, payables, and receivables management, organizations will be better positioned to secure adequate cash flows and manage short-term commitments in the months ahead. If you need additional funds to supplement your working capital reserves, reach out to Tata Capital to know the best-suited working capital financing solutions for your business.
27 May 2021
5 mins read
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