What Are the Elements of Working Capital Management?
Part of a business’s success relies on working capital. What is working capital? It is the amount of money a business has left over after subtracting current expenses from current revenue. Businesses should have enough working capital to cover any unexpected expenses that occur while they are still expanding. That’s where working capital management comes in. This type of management allows businesses to track and make decisions concerning their short-term cash flow, including operating costs and short-term debt obligations. Businesses should maintain a good balance between how much they spend and how much they save. Spend too much, and your business won’t be able to pay its debts. Spend too little, and your business can’t grow.
To get a full understanding of working capital management, it’s important to understand its objectives as well as the different types of working capital management elements.
What Are the Three Objectives of Working Capital Management?
The three objectives of working capital management are:
Cutting Costs: Your business should make sure to avoid spending money on unnecessary items. You can also cut costs by making your products with less expensive materials of the same quality or making sure to hire people who seem like they’ll work for you for a while.
Maintaining Operating Cycle: You should make sure that things such as low inventory and insufficient working capital do not disrupt daily operations. If they do, it could affect sales and a customer’s trust in your business. By maintaining your normal operating cycle, and even trying to shorten it if possible, you will boost sales and confidence in your business.
Increasing Return on Investment: Maximizing your business’s return on investment will increase the money you can save and put towards operations, expansion, and development of new products or services. A couple of ways that you can improve the return on investment are to raise prices or to grow sales.
How do you achieve these objectives? Actively addressing each of the elements of working capital management.
4 Elements of Working Capital Management
There are four elements of working capital management: management of liquid assets, accounts payable, accounts receivable, and inventory. If your business pays attention to each element, it will make better use of your working capital.
Liquid Asset Management
Liquid management is the way in which businesses handle their liquid assets, meaning anything that can easily be converted into cash if needed, as well as cash itself. If your business has low liquidity, it may run into financial issues because it cannot pay for normal operations or other bills. This can lead to lower creditworthiness. If your business has high liquidity, it means that your business isn’t allocating enough money to expand. For a healthy financial situation, your business should find a nice balance between the two.
Accounts Payable Management
Accounts payable management is the way in which businesses handle the payments and debts they owe. Your business should find a healthy balance between making payments early and on time. The problem with waiting to make payments until the day they’re due is that an unexpected expense might arise that eats up all your working capital. You won’t have time to earn the working capital necessary to make your payment, which can affect your business’s chances of receiving more short-term or long-term funding and, if it happens often, can even hurt your business’s creditworthiness. This, in turn, could negatively impact your business’s reputation.
On the other hand, making payments too early can also cause issues by decreasing your liquid assets that might be needed for other expenses, such as unexpected costs, creating a new product, or hiring new employees. You may be tempted to pay expenses early to get them off your plate, but before you do, make sure you will still have enough liquid assets to cover any other costs you may have.
If you find your business in a situation where you do not have the working capital you need to pay for an unexpected expense or growth opportunity, Backd offers alternative funding with a quick application process.
Accounts Receivable Management
Accounts receivable management is the way in which businesses handle the debts owed to them by customers. This includes unpaid invoices and products or services paid for on credit. Allowing customers to pay on credit or deliver products or services before a customer has paid for them makes your business attractive because it shows customers that you trust them, which can lead to a sense of loyalty for your business.
At the same time, though, you have to make sure that your business has the money it needs to pay for its day-to-day operations. It won’t have that if your customers do not pay you for what you give them. To balance the two sides, your business should give customers a set deadline for all payments upfront.
Inventory costs money to buy and makes your business money once sold. Proper inventory management involves finding the right amount of inventory to have at any given time. If you buy too much inventory, you risk having money tied to items that aren’t selling. If you buy too little, you face the possibility of running out and losing sales. To find that balance, look at your business’s data on what is selling well, what isn’t, what time of year those items are selling, and how much similar items in the market are selling for.
Backd: Your Source for Short-term Financing
No matter how well you manage your money, you may face times when the working capital you have won’t cover an unexpected cost you have to pay or the expansion you had planned on. That’s where Backd comes in. We offer short-term financing of anywhere between $20,000-$2,000,000 so that your business can get back on its feet. We even let you set up a repayment schedule that works best for you. Ready to apply? You can do so in less than ten minutes here.