The Importance of Responsible Working Capital Management
Balancing your short-term assets and liabilities is a continuous responsibility. Ultimately, working capital is an immediate requirement that can positively or negatively affect your business’s long-term goals.
What Is Working Capital?
Essentially, working capital is the cash available for your day-to-day operations. There are several types of working capital: fixed (like locked-in cash), regular (needed to run daily operations), reserved (any money you have in addition to your daily needs, in case of emergencies), and temporary/variable (for seasonal businesses or those affected by a special event).
Overall, working capital depends on your business’s operating cycle, which starts when funds leave the company to buy products or services, to the time it is returned back as revenue from a sale.
It’s when you’ve spent a large chunk of money and are waiting for it to return to your business that working capital becomes important. If your business can’t sustain operations during this time, you’re highly unlikely to make sales to get your money back. In addition, if your business has multiple operating cycles occurring at the same time, the situation can become stressful.
The consequences of poor working capital management can severely affect your business. On the other hand, properly managing your working capital guarantees your business will flourish.
The Good: Improved Credit Score
Paying back debts while generating revenue ensures your operating cycle is funded, and it’ll likely boost your credit score. Of course, this means making on-time and frequent payments to your lender. Once you have a higher credit score, you’ll qualify for a lower-rate loan or line of credit, and you’ll have peace-of-mind knowing that your business is in good financial standing.
The Bad: Financial Insolvency and Lower Credit Score
When you’re unable to repay debts, but are still running your business with low operating costs, creditors will try to get their funds back. If you’ve been in this situation with your personal debts, you know that creditors call you as soon as your delinquency is reported to the credit bureaus.
By the time you get a call, your credit score is lowered by a few points already. The longer your debt goes unpaid, the lower your business’s credit score will drop. Ultimately, this digs you deeper into a hole that’s difficult to climb out of.
Asking your creditor to lower the payment amount and increase the payment schedule length can help resolve the issue until you’re producing more income. This is the responsible way to rectify the situation, and will help you avoid bankruptcy.
The Good: Increase Your Profits
Managing your working capital correctly can result in a revenue boom. This means more business assets that you can spend on additional costs, like equipment and software. Plus, you can invest these extra funds in marketing after your daily needs are met, furthering your business growth.
Over time, optimizing your working capital to go lower will increase profits over time. Ultimately, you’ll gain a competitive advantage over your peers because your supply chain logistics are working at a lower cost. This will inevitably lead to more customers and higher production value.
The Bad: Liquidation of Assets
If you’re not repaying your debts due to low revenue, creditors will try to repossess any collateral you offered in your application. This puts you one step closer to bankruptcy; even though it feels terrible to let your yacht go, think of it as the price of continuing business. After your lender repossesses your collateral, you should be free from most obligations on that debt.
The Good: Ability to Face Emergencies
Properly managing working capital means you will eventually have some extra funds. We recommend saving these funds for emergencies. The ability to face last-minute problems without dipping into a loan is priceless. Your business will be better because of it.
Similarly, if you get an unusually high volume of orders, you can use your reserved working capital to quickly deliver. This increases your business’s value.
The Worst: Bankruptcy
When revenue is non-existent and your business’s bank account is almost empty, it’s impossible to stay afloat. Between paying bills, marketing your business, and paying off debt, your funds are no longer fluid. This will make it challenging to repay your debts and grow your business.
Successful management of working capital means your business can handle repaying debts when they are due, and that paying back debt isn’t taking too much out your bank account. If you’re in this position, monitor your spending and debt payment schedules. Optimize operational costs and your operating cycle for profit. In addition, determine if your short-term debts can convert into longer-term payment schedules with lower payments. And if you have any unpaid balances, follow up right away or sell the invoices for liquid funding.
Your Business’s Bottom Line
The difference between poor and proper working capital management can lead to business success or result in bankruptcy. Although working capital sounds like a “day-to-day” duty, it’s important to involve all stakeholders who oversee the big picture. Knowing how much working capital your business needs to function will vary, but it’s important to deduce this, plan accordingly, and, of course, manage it responsibly.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.