by Working capital is considered to be the lifeblood of a business. There needs to be a steady flow, especially in the initial and expansion stages of a business. If working capital gets stuck, it can push a business towards failure. This grave significance is why one out of five MSMEs in India is expected to require increased working capital in FY23.
Effective working capital management, while useful to maintain cash flow, can have other benefits. It helps you achieve a higher rate of return on your capital and assets. This increases profitability, value appreciation, and liquidity, all at once.
Supply chain finance is a strategy that unlocks liquidity trapped within the supply chain, enabling businesses to better optimise cash flow. To manage positive working capital levels, businesses need to approach it in tandem with supply chain finance. This, eventually, allows for better funding opportunities in the future. Read on to know more.
Working Capital Management: Purpose and Relevance
To efficiently run day-to-day operations, a constant supply of working capital is a must. To arrive at working capital, you can use the formula:
Capital Assets – Capital Liabilities = Working Capital
When current liabilities exceed the assets, working capital becomes negative. Without the funds needed to make payments to vendors, employees, and lenders, companies get pushed into a state of immobilisation.
To prevent this, you need to set up a system for efficient working capital utilisation. This is made easier when companies avail supply chain finance solutions.
Role of Supply Chain Finance in Working Capital Management
While working capital management is a business process used to optimise cash flow in a business, supply chain finance is a set of business and financial processes. It is also known as supplier finance or reverse factoring.
Simply put, it aims to reduce financing costs for the buyer and the seller involved in a sale. While procuring materials and products, you can apply for funds from a lender such as a bank or NBFC. This allows you to have funds readily available to make advance or early payments to suppliers.
This, in turn, allows you to negotiate better terms from suppliers, such as extended payment periods. Meanwhile, your supplier can provide products more quickly, to receive payment from the lender. This facility of short-term credit optimises working capital and provides liquidity to both parties by leveraging supply chain finance.
Suppliers receive the money they are owed without needing to wait for the completion of the business cycle. Also, you get more time to pay off what you owe. This encourages a collaborative buyer-seller relationship. It additionally allows you to preserve your company’s working capital to keep operations running smoothly.
Supply chain finance helps your business overcome nuanced complexities and ensures that your working capital flow is not impacted.
Importance of Effective Working Capital Management for Businesses
Proper management of working capital comes with many benefits for businesses, namely:
- Improved Liquidity
Proper estimation of working capital allows you to maintain adequate cash levels to address planned and unexpected scenarios. With operations in full control, it facilitates easier decision-making regarding other aspects of the business.
- Enhanced Reputation
A high working capital ratio signifies a company’s liquidity, efficiency, and short-term prospects. While benefiting from supply chain finance, you can also build a strong credit history through timely payments to the lender. This enhances your brand image and creditworthiness among peers and lenders, improving future funding prospects.
- Increased Business Valuation
Effective working capital management leads to efficient utilisation of all company resources, including funds and assets. This paves the way for profitability and growth, which increases your share price or business valuation. It also attracts other businesses and investors to work with you.
- Higher Returns on Capital and Assets
Often, poor management of working capital components such as raw materials and finished goods, leads to fixed assets remaining idle. This comes at a great cost to the business, also implying that you are getting poor returns on your invested capital. Effective working capital management can help avoid this, allowing you to reap maximum benefits from capital and assets.
Effects of Working Capital Management on Business Loan Approval
Companies that can show a positive working capital figure or a high working capital ratio have higher chances of qualifying for an online business loan. Here’s how:
- Easier Loan Approval
Working capital indicates a company’s short-term financial health. Positive figures displaying sizable operating profit proves robust financial health. This will encourage lenders to extend funds to your company, especially unsecured business loans.
- Improves Eligibility for an Online Business Loan
The company’s credit score is largely influenced by your ability to pay off dues on time. When you make timely payments while generating profit, your credibility as a business increases. This leads to a better credit profile and higher credit scores. A good credit history also prompts lenders to offer you an online business loan.
How to Improve Working Capital Management
Effective working capital management is the solution if you are seeking ways to stabilise the cash inflow and outflow in your company. Here are a few ways to incorporate this in your business:
- Reduce outstanding liabilities
- Effectively manage inventory
- Lease equipment when possible
- Don’t mix personal and business expenses
- Line up multiple sources of funding
Overall, effective working capital management is fundamental to businesses, irrespective of industry and business size. While it largely influences funding opportunities, its scope is wider. It is a hygiene factor for holistic company growth and it impacts employee satisfaction, supply chain, operating cycle efficiency, and much more.
While it is imperative to maintain working capital, you don’t have to employ equity every time there is an increased need. If it aligns with your business plans, you can opt for short-term working capital loans and online business loans. Make sure you do a thorough analysis of all the financing options available to you, before applying.
