What Is Working Capital Management and Its Types?
In order to properly assess your company’s entire financial well-being, you must possess direct insight into your working capital and streamline your working capital management processes. Regardless of the specific factors determining your working capital needs, all management frameworks should be designed to:
Maintain financing for critical operations
Spend as little as possible to achieve goals
Meet high-quality standards
Maximize return on any investments
Sure, it’s easy to say all of this but how should a business approach working capital management and create a strategy that truly works for them? Let’s find out.
What Are the Types of Working Capital?
Before deciding on a working capital management strategy, you need to understand the different types of working capital and determine how each type applies to your business.
The Four Main Types of Working Capital
Net Working Capital
As the primary working capital figure, net working capital serves as a baseline for determining all other types of working capital. A company’s net working capital accounts for how much money is available to fund immediate expenses and provides insight into a company’s short-term financial well-being. This means calculating the difference between your current assets and liabilities.
Long-Term Working Capital
Long-term working capital, sometimes called permanent working capital, includes current assets that are absolutely essential for a business to keep running at full capacity.
Short-Term Working Capital
Short-term working capital, also known as temporary working capital, accounts for the fact that a business’ revenue often fluctuates. When an opportunity arises, a business might require additional working capital to effectively take advantage of that opportunity. At its core, short-term working capital is all about accounting for natural fluctuations in business experiences in its net working capital.
Operating Working Capital
Operating working capital is a narrowed-down version of net working capital. This figure accounts for how much capital a company needs to sufficiently fund all aspects of its day-to-day operations.
What Is the Concept of Working Capital Management?
Now that we’ve discussed the different types of working capital, it’s time to discover what makes a successful working capital management strategy. On a basic level, a working capital management strategy allows businesses to prioritize and track their short-term cash flow. A strong working capital management framework helps business leaders align their decision-making with established goals and gain an accurate picture of what state of their finances. This involves evaluating the four following assets and liabilities:
Accounts Receivable - How much customers owe your business.
Accounts Payable - How much your business owes overall.
Inventory - Products, materials, and service hours that your business has available.
Cash and Bank Reserves - The amount of money available for unexpected and future expenses.
Types of Working Capital Management
Currently, there are three types of working capital management. Depending on your business’s needs, you may choose just one of these approaches or even combine them.
Aggressive
Taking an aggressive approach to working capital management means that the amount of funds available in the short term is not abundant. This approach is often used during a period of growth where a company needs to spend money in the present time to make more money in the future. Although this means there is not a lot of money left over to maintain a financial cushion, the business will have enough funding to cover its current expenses. An aggressive working capital management style should be implemented wisely and is not a sustainable strategy for the long term.
Conservative
A conservative working capital management model is the foil to an aggressive approach. Taking a conservative approach means that short-term costs are financed with long-term sources of revenue. This means that a business has more money available to deal with unexpected costs and shifts in the marketplace. If a business experiences a surplus, those funds are then invested in marketable securities.
Hedging or Matching
In a matching model, also called a hedging model, working capital management adjusts based on what expenses are being paid for. For example, short-term daily expenses are paid using current revenue or short-term financing options. On the other hand, long-term liabilities are paid using long-term financing loans.
Get the Support You Deserve With Backd
From hiring more people and renovating your building to purchasing updated equipment and resources, every business will need a short-term financing solution somewhere down the line. As an alternative lender, Backd offers extremely competitive interest rates and flexible repayment plans. Additionally, our working capital solutions offer funding from $10k-$2M and term lengths of up to 14 months. This means Backd can cover whatever is needed without all of the unnecessary stress. Apply now and get the support you need to level up your business!
