Effects of Poor Working Capital Management
Small and medium enterprises are particularly vulnerable to improper management of their assets and liabilities. Most SME assets are in the form of current assets and their current liabilities are often a source of external finance, given the difficulties of getting a business loan for such enterprises. Oftentimes, SMEs have to resort to vendor financing when facing a capital crunch. Therefore, efficient working capital management becomes critical for the success of a small business in India.
Working capital is the difference between your current assets and current liabilities. It is primarily used for supporting the day to day financial operations, such as the purchase of stock, salary and wage payments, and financing credit sales. In essence, working capital is the lifeblood of a business.
Working capital management is the managerial strategy for creating a balance between the two aspects of working capital i.e. current assets and current liabilities. Working capital management ensures that there is enough cash flow for meeting short-term debt and operating expenses. Efficient management of working capital is a part of effective corporate strategies and helps in creating shareholder value. However, maintaining the liquidity of a firm is also an important part of working capital management as increasing profits at the cost of liquidity can also have serious ramifications for an SME. In case, profits are ignored, a firm cannot conduct operations for long, and if liquidity is ignored, the firm may face insolvency. So, working capital management should be given due consideration in strategic management of a company.
If your cash flow is constantly at odds with your working capital requirements, the reason might be a de-synchronization between one or more of working capital determinants. Here is a list of working capital determinants / reasons why your firm is struggling to acquire the necessary working capital buffer for operational expenses and short-term debt obligations.
Nature of business:
The type of business your company is involved in does have an impact on your overall working capital requirements. For example, trading and investment firms very little capital in form of fixed assets but do require larger working capital funds for operation. On the other hand, firms offering public utilities do not have a huge working capital requirement but do need to invest in fixed assets. So, the first thing you need to check is whether the nature of your business is properly aligned with your financial policy for generating the working capital.
Sales and demand:
Working capital also has a relationship with the volume of sales. Again, this relationship varies based on the type of your business but in most cases requires the deployment of fixed assets to spur growth. So, if yours is a growing enterprise, make plans in advance for a continuous change in working capital needs – and how you are going to meet them – as per the existing sales and demand scenario.
If you are manufacturing products, using the right technology is crucial for better working capital management in your enterprise. Manufacturing has a direct relationship with increase or decrease in working capital funds. The longer the manufacturing cycle, the higher the firm’s working capital requirements. This, pick and choose the right technology to streamline your working capital and manufacturing process.
If you have a credit policy that differs too much from the norms in your industry, you may find yourself having working capital troubles. It is good to be able to offer better credit terms to your buyers as the part of your customer acquisition strategies, but it is similarly important to limit that flexibility within the constant of industry norms and practices.
Another factor that relates to the delivery of goods and services is the operating efficiency of your business. It has a direct effect on your working capital requirements. Pushing your operating efficiency to the maximum will not only decrease your working capital requirements but also improve your profit margins.
Price Level Changes:
Change in the price of raw materials, packaging for finished goods, transportation and sales costs, can also increase or decrease your working capital requirements. Being able to anticipate and adjust accordingly to these price level changes is a part of effective working capital management. If you are being let down by the volatile price level changes, consider hiring an expert to stabilize your working capital and other financials.
A firm’s working capital requirements are also subject to supplier credit. If your supplier trusts you enough to grant higher credit in lieu of raw or unfinished goods and services, it can reduce your immediate working capital needs. So, cultivate stronger relationships with select suppliers instead of regularly switching from one to other.
Lastly, the type of institute credit available for your business also has an effect on working capital requirements. If you can get business loans easily, your working capital needs will not suffer. But if your business loan applications are continuously being put on hold, it may not bode well for your working capital and cash flow. In such cases, try applying for a business loan with non-banking financial companies offering working capital finance for SMEs. For example, Lendingkart Finance is a FinTech firm that offers business loans up to ₹ 1 crore without any collateral requirements. Lendingkart’s business loan offers include approval and disbursal within 3-days of verification, which makes it instant business loan, faster even then the Indian government’s ‘MSME 59 minutes loan’ offer.
We hope, these pointers for identifying working capital issues will help you manage your organisation better and grow organically. To know more about working capital finance and how you can get small ticket short-term finance for your growing business, email us at firstname.lastname@example.org or call us on 1800572 0202.