working capital

Why Managing Working Capital is Important for Future Funding?

October 26, 2022 • 3850 views

Working capital is the fund required to meet your current and short-term goals. Working capital is the lifeline of any business, as it provides the required funds to run daily operations. It affects many aspects of your business, such as paying your employees and vendors and planning for future growth. Understanding the importance of working capital management is crucial for a business owner. It will enable to effectively manage their finances and expand their operations. In this blog, we will discuss the importance of working capital, the calculation of working capital, ways to increase it and more. 

What is Working Capital?

Working capital is the funds your business requires to perform everyday activities, such as purchasing inventory or paying bills. It is the difference between your organisation's current assets and liabilities. Working capital is commonly used to measure the organisation's short-term financial health and liquidity.

Here is a representation of how you can calculate your business's working capital:

Working Capital = Current Assets – Current Liabilities

  • Current Asset

It includes assets which can be easily converted or sold within a year of purchase. These consist of stock, cash and cash equivalents, marketable securities, accounts receivable, etc.

  • Current Liabilities

It includes liabilities that you can pay off in a year, such as accounts payable, income tax, payroll due, payroll taxes, interest payable, short-term debts, rental fees, etc.

Example of Working Capital

For instance, your business has current assets worth Rs.10,000 and current liabilities worth Rs. 8,000. Hence, the working capital of your business is Rs. 2,000.

What is Working Capital Management?

Working capital management refers to managing your current assets and liabilities effectively so that you can increase your profits efficiently. Managing working capital creates sufficient cash flow in the business, helping you easily tackle various short-term financial requirements.

However, there may be constant changes in the external and internal business environment where you may require additional finance to manage your day-to-day business requirements. In such situations, availing a Business Loan for working capital will help you meet your financial requirements. It will enable you to fulfil your daily operations, short-term expenses, emergency expenses, etc.

Also Read: Boosting Operational Efficiency with Working Capital Finance

8 Importance of Working Capital Management

Here are 8 notable reasons why working capital management is crucial:

1. Business Expansion

Having enough working capital in your business helps it to grow and expand. Working capital will give a clear idea of your current assets and liabilities that you can manage effectively to expand your business. It will also enable you to purchase more inventory to increase your business's sales and profitability.

2. Improved Liquidity

Working capital ensures that your business has adequate cash on hand to fulfil your short-term financial requirements, like paying employees, rent, suppliers, and other costs. Moreover, liquidity refers to those assets that you can easily convert into cash and deal with expenses and short-term payments.

3. Better Utilisation of Fixed Asset

Since most of the fixed assets remain idle due to insufficient working capital, the organisation has to pay funds on borrowed funds and pay the depreciation of such assets. Hence, having adequate working capital in your business and efficiently managing it will enable you to utilise your business's fixed assets effectively.

4. Better Financing

A business with a reputation for managing working capital efficiently and clearing off dues on time will have a higher creditworthiness and score. Hence, it enables them to avail a Business Loan from financial institutions at favourable terms and lower interest rates than other competitors in the market.

5. Business Value Appreciation

If you manage your business's working capital efficiently, it will have a reputation in the market for being creditworthy. It will improve your business's goodwill and simultaneously increase its share prices or market value. Having a higher market value indicates higher wealth creation for business owners.

6. Increased Profitability

Another important aspect of working capital management is an increase in the business profits. Having a balanced working capital management policy for schemes, like cash discounts, Equated Monthly Instalments (EMIs), etc., reduces the overall interest cost. Hence, it results in generating huge profits for the business.

7. Improved Decision Making

Managing working capital is essential for a business as it helps them to make informed decisions. It helps companies calculate their day-to-day fund requirements and evaluate their existing funds. Hence, you can manage your business effectively to overcome any insufficiency of the working capital requirements for daily operations.

8. Short-Term Profits

Sometimes, your business may have excess working capital than required. As a business owner, you can invest extra working capital to generate short-term profits rather than keeping the funds as working capital.

Also Read: Boosting Operational Efficiency with Working Capital Finance

Advantages of Sufficient Working Capital

Having sufficient working capital in your business enables you to manage your daily business operations and other short-term requirements. The following are some key advantages of having sufficient working capital:

  • Suppliers may offer cash discounts when you repay their bills in a timely manner. It enables you to reduce costs and increase your profits.
  • Paying suppliers promptly helps in improving the business's goodwill and creditworthiness.
  • It assists in maintaining the company's solvency by effectively managing an uninterrupted process cycle.
  • Adequate working capital enables you to manage any financial crisis or market fluctuations.
  • Since it improves your business's creditworthiness, you can easily avail of a Business Loan at favourable terms and lower interest rates.
  • It enables you to manage the company's expenses and bills effectively, like taxes, staff salaries, etc.
  • You can divert the excess working capital to productive ventures to earn more profit for the business.

Ways to Increase Working Capital

After understanding the importance of working capital management, you must know how to manage it. Here are a few ways through which you can increase your working capital:

1. Opt for Loans

You can avail of a Business Loan from NBFCs like Poonawalla Fincorp to manage your business's daily objectives. It will enable you to fulfil your business's short-term goals and day-to-day financial requirements.

2. Manage Inventory

You can maximise your inventory or stock management process by reducing the finished goods and raw materials overstocking.

3. Reduce Expenses

You can achieve operational efficiency by reducing unnecessary expenses wherever applicable to balance working capital loan.

4. Sell off Illiquid Assets

Selling off illiquid assets will increase the cash in hand, improving the cash position in your business. Hence, it will increase your working capital to fulfil your daily financial requirements.

5. Automate Receivable Process

Automating the receivable process will enhance the cash flow of your business. It will also minimise fund use from other sources to fulfil daily business requirements.

Business and Personal Credit Score

If you want to avail a Business or a Personal Loan, you must have a good credit score. The credit scores of these loans are calculated on similar parameters with some minor differences. Here is a table illustrating the basis of Personal Loan credit score and Business Loan credit score check:

Personal Loan Credit Score Check

Business Loan Credit Score Check

Debt-to-income ratio

Repayment history

Credit utilisation

Open lines of credit

Repayment behaviour and history

Business vintage

Credit mix

Past collections

Latest loan applications

New lines of credit

 

Though a Personal Loan and a Business Loan are closely related, in some cases, lenders will check your personal credit score before approving your Business Loan. If your business comes under the MSME category, financial lenders will consider your personal credit score. In addition, they will also consider your personal credit score if you do not have a substantial credit history, you are a self-employed individual or a sole proprietor.

To Conclude

The importance of working capital management cannot be ignored, as it plays a crucial role in improving the profitability and creditworthiness of your business. It also assists you in meeting your short-term financial requirements and growing your business. Having a balanced working capital enables you to meet your daily financial objectives without any restrictions.

Also, if you want a loan to arrange for your company's working capital, check Poonawalla Fincorp's Business Loan. It will enable you to get a higher credit with lower interest rates and favourable terms.

Frequently Asked Questions

  • Why is working capital important in a business?

Working capital in a business assists you in meeting the day-to-day financial requirements of your business and growing and expanding its operations. You can also allocate the extra working capital to your business to earn higher profits.

  • How to calculate the working capital of a business?

You can calculate your business's working capital by subtracting the current liabilities of your business from its current assets.

  • What is the primary concept of working capital?

The main concept of working capital is that your organisation must have adequate cash available to manage daily operations and short-term loans.

Disclaimer

We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Business Loan disbursal is at the sole discretion of Poonawalla Fincorp.
*Terms and Conditions apply

poonawalla fincorp team

Poonawalla Fincorp Team

Our team of expert writers and editors are passionate about providing authentic and valuable information on finance. Our aim is to simplify financial and finance-related concepts. We strive to help our readers become more aware and empowered to make informed financial decisions.

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