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Working capital: you can’t make your business work without it.
 
In this two-part blog series, we’ll take a look at what working capital is and how you can identify and correct inefficiencies to streamline cashflow and support sustainable growth.
 
First, let’s start with a basic definition of working capital, aka net working capital (NWC). It’s the difference between a company’s current assets and its current liabilities, and it represents the resources that can be used to carry out day-to-day business activities.
 
As a key financial metric, working capital can indicate a company’s operational efficiency and ability to meet short-term obligations. If a company has insufficient or negative working capital, it risks not being able to keep the lights on. Conversely, if a company has excess working capital, it could mean that they’re not investing enough in long-term assets and growth strategies.
 
While there are no hard and fast rules when it comes to the right balance, many business analysts recommend a ratio between 1.2 and 2.0.
 
As an example, let’s take a look at this excerpt from Company XYZ’s balance sheet:
 

Cash and cash equivalents	$20,000	Accounts payable	($50,000)
Accounts receivable	$80,000	Notes payable	($15,000)
Inventory	$55,000	Accrued wages	($25,000)
Investments	$25,000	Taxes payable	($10,000)
Total Current Assets	$180,000	Total Current Liabilities	($100,000)

 
In this instance, Company XYZ’s net working capital would be $100,000, with a healthy ratio of 1.8.
 
Now, let’s take a closer look at three major elements of working capital – receivables, payables, and inventory – and how you can manage them for better financial performance:
 
1. Receivables
Receivables, or accounts receivable (A/R), are the funds due to a business from customers for goods or services provided.
 
They’re classified as current assets on a company’s balance sheet and are part of the working capital formula, but that money can’t be used to cover expenses until it’s collected. If your company has a high volume of sales on credit, even a slight decrease in your average collection period can significantly increase your cash on hand.
 
Strategies for getting paid faster include negotiating shorter terms with customers, providing discounts for early payment, and offering a range of convenient payment methods.
 
2. Payables
Payables, or accounts payable (A/P), are the funds that a business owes to suppliers or vendors.
 
While you want to collect receivables as quickly as possible, delaying payables as long as possible is often a best practice for an enhanced cash position. Many companies routinely wait until the end of each payment term unless there’s a discount or other incentive to pay early.
 
For businesses that have a shorter payables cycle than receivables cycle, it can be smart to strive for relative parity. Cash management tools like controlled disbursement services can help companies to optimize the timing of vendor payments.
 
3. Inventory
Inventory, or stock, refers to the goods and materials that a business uses in production or holds for resale at a profit.
 
For inventory-based small businesses, it’s essential to implement a system that meets customer demand without tying up too much capital. Your specific industry and prevailing market trends will determine whether you need a “push” system (with a generous supply of finished products on hand), a “pull” system (where inventory is sourced on demand), or a happy medium.
 
Careful demand analysis can help you find a solution that keeps your inventory low without hurting sales or increasing procurement costs.
 
Stay Tuned – and Stay in Touch
In our second installment, we’ll take a deeper dive into strategies for addressing working capital gaps and planning for the future. In the meantime, if you’re looking for fast, fair, reliable, and transparent financing for your small business, consider Nu Direction. Owned by not-for-profit credit unions, we bring you the speed of fintech with a personal touch.
 
Learn more and apply online in minutes.
 
 
The information contained herein is for general informational purposes only and does not constitute tax, legal, or business advice.
 
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