Impact of Working Capital Management on The Profitability Of Firms

It takes a lot of courage and conviction to venture into an unknown territory leaving behind a comfortable job and an attractive package to start a business. Your business idea can turn into a reality provided you have the right vision and the financial capacity to achieve the same. Firstly a business owner has to ensure there is enough capital to run a business because it is a significant component before any investment is made.

Let us understand the aspect of working capital in a business.  A business owner has to keep working capital intact to manage costs like payroll, rent and debt payments. All businesses are different in terms of their operations. Some businesses have cyclical sales and may not have predictable revenue generation throughout the year. For instance, some manufacturing companies with cyclical sales depend on the requirements from retailers. If a retailer sells at a particular time of the year then the manufacturer will supply goods during that period. However, once the sale period is over the demand from the manufacturer also ends. During this period, the manufacturer will need working capital to pay wages to labourers. Besides the cyclical nature of the business, there are occasions when business needs are unpredictable, and there is little control over situations. The business owner may not be able to deal with such situations in the absence of working capital. It is when business owners reach out to banks and financial institutions for working capital loan for new business in India.

Get the basic of working capital

It is better to be prepared by setting up an emergency fund through the management of short-term assets and liabilities. Working capital includes short term assets of the company used for its operations on a daily basis. It is an indicator of measuring the liquidity in terms of cash required to meet the company’s obligations. The working capital management has implications on the firm’s profitability and risk as well as its value.  It is a sensitive area in the field of financial management because it can affect the firm’s success. You should be able to maintain optimal levels of working capital through various components including cash receivables, inventory and payables etc.

The working capital management should remain a higher priority for any business because shareholder’s wealth and firm’s profitability is a lot dependant on it. If you fail to manage the working capital you will default on bills on the maturity date. The best way is to ensure that the money coming in is more than the money going out of the firm. Typically working capital can be defined as the level of inventory held, where under-utilised excess inventory could become a cause of worry and shortage may restrict you from meeting the business targets. However, you can tide over the crises through a business working capital loan which is easy to acquire.

Most importantly, the ability to maintain business operations depends on the level of investment made in the working capital.  An ideal working capital can be achieved through a balance between profitability and liquidity. Remember, excessive investment in working capital may reduce the profitability of the firm but the shortage may put you in a risk where you are unable to meet obligations. Hence, working capital is deemed as an effective management technique to guarantee long-term success. Here are few ways in which effective working capital management can ensure profitability:

Managing allocation of resources

The most important aspect in working capital management is proper allocation of resources. As a business owner, you need to analyse and come out with allocation of existing resources to various areas of business deemed appropriate. This kind of analysis determines shortage or surplus in resources, and help you take desired action to bring it back to the desired ratio. This also means efficiently managing stocks so that the firm has sufficient resources to meet production or supply needs.

Maintain transparency in dealings with suppliers and creditors

One of the requisites in business is to main a cordial relationship with suppliers. With an effective working capital management system, you can ensure transparency in dealing with suppliers and creditors. If you have managed to create goodwill with your business partners, it can help you get access to easy working capital loans faster, compared to others in the market. A working capital loan for your business can be easily approved if you have a good track record with your suppliers and creditor. It also simplifies the process of availing finance.

Create a sound investment portfolio

A successful business always intends to invest in resources effectively either for expansion or achieving better standards in executing the existing projects. With effective working capital management, the business can release funds into new areas of business or enhance existing investments. Effective working capital management also ensures better maintenance of records. A clean book maintained through various working capital ratios can help financial experts and analysts get a clear picture of your business.

Impact on operational efficiency

An effective working capital management system can help in controlling resources and finances as these aspects are crucial in functioning of the business. This reflects on the operational efficiencies which lead to better performance of the entity over a longer time. This also saves on financial costs, time, effort and energies spent in managing short-term assets and liabilities. If you have a proficient working capital management it will have a positive impact on the profitability of any business organisation.