Understanding Working Capital and its importance to your Business Growth

How eager are you to see your business attain the growth you desire? Noting delights the mind of a business startup than to see it grow tremendously. While you may not talk about working capital every day, this may be the missing jigsaw on the journey of your business to significant growth.

It is not out of place to see budding and promising startups remain stagnant after a few years of operation despite significant assets and healthy profitability. Sadly, some even die off totally and get liquidated. What exactly could be the problem here?

While there are many factors that could be responsible for this unfortunate trend, one major culprit that has been a common factor in several cases is the lack of operating or working capital. Without work capital, no business can thrive. The best it will do is to survive for a limited period of time before it gets cleared off the operation radar by other threats.

This article will explain working capital in-depth and its importance to business growth.

What is working capital?

Simply put, working capital is defined as ‘current assets minus current liabilities. This is the financial gauge used in calculating the operating liquidity available to a business. In turn, this determines what cash is available to a business at any given time, once all the responsibilities have been met in the course of running the business.

In clearer terms, if a company’s finances read that it has a total current asset of ₦300,000 and total current liabilities of ₦100,000, then its working capital is ₦200,000. Your current asset includes all liquid assets such as cash, receivables, and short-term investments. Whilst your current liabilities are your payable and short-term debt. One way to get a better understanding of the working capital for your business is by paying attention to the work/capital ratio.

What is Working Capital Ratio?

You would agree that calculating working capital requires understanding the balance between current assets and current liabilities. This is the exact reason why some people use the term ‘working capital ratio’ as a synonym for the specific amount in dollars. However, it is much clearer and easier to understand when you are referring to an actual ratio which is the proportion of current assets to current liabilities.

Taking the example mentioned earlier that values a company’s current assets to be ₦300,000 and its current liabilities are ₦100,000 the current ratio will rightly be 3:1, which is a great thing in this case. This means that the business owner has enough assets to repay its current debt. It is agreed by many financial experts that when the current ratio goes below 1:1 in favor of debt, the business is in a state of bankruptcy and the further it dips, the lesser its chances of being dissolved.

To get a better understanding of working capital and its importance to your business growth, you need to understand the concept of the working capital cycle and working capital management.

What is the Working Capital Cycle?

In any profit-oriented establishment, it takes a certain number of processes before current assets and liabilities are turned into cash. This process is referred to as the Working Capital Cycle (WCC) and the time the cycle takes to complete is very crucial to the measurement of business growth.

It assists in pointing out where work capital is tied up in the processes of running the business before business owners earn a return on it. To this end, it makes perfect sense for companies to consciously track their WCC. That way, they will definitely experience an improvement in business efficiency. This is why working capital management is a crucial factor in the quest to achieve business growth.

What is Working Capital Management?

Working capital management is the general business tag given to the process of ensuring the cash movement in all the crucial organs of a business establishment. To ensure business survival and growth, the management of a business needs to manage its current operating expenses as well as debts that crop up from time to time.

To get this right, there is a need for a highly organized managerial accounting strategy. This usually involves the continuous monitoring of the work-capital ratio(as mentioned earlier ) and giving an analysis of what the current situation means for the business, inventory management, and management of accounts receivable and payable. However, it is only necessary to follow this duly when running a big business. Now, it is time to examine if all the noise around work capital is worth it and how it affects business growth.

How important is Working Capital to Your Business growth?

How exactly does working capital impact business growth? When you have enough working capital, your business has better chances of surviving and even going further to thrive. You won’t only be clear of debt from loans but you would find your business breaking out to the next scale of enterprise.

Here are some of the most common effects of work capital on your business:

1. You will have the Purchasing power to procure needed inventory before the busy season in your industry
2. You will have an increased capacity to hire and train additional staff at any given time if there is a need for it.
3. You would be able to procure Short-term working capital loans if there is a need for it without depleting your working capital (due to the availability of an impressive credit-score).

It is interesting to see that robust working capital is easier to protect than a fragile one. That is why it is imperative to make conscious efforts to improve the robustness of your business’ work capital. For businesses that are struggling financially, one way to procure a working capital is by obtaining a loan. While some business owners might feel this is an unnecessary move, it has its functions in the smooth running of the business.

Why you might Consider Working Capital Loans

Here are some genuine reasons why you might need a working capital loan –

1. You’ll like to expand your product line and require additional capital to do so.
2. Business management is able to expand its business mode of operation
3. There’s a need to quickly offset certain operational expenses such as rent and salaries.
4. It gives the business the latitude to pay off silent or ineffective business partners (in the event of a partnership)

Work capitals obtained in form of a loan can only be with you for a limited period of time. Because you have to pay back the loan, and it will be out of your working capital cycle thereafter, it is crucial that you improve it while you have it in your kitty.

How you can improve Working Capital

These are a few tips to help the management in strengthening work capital when running a business –

1. More efficient collection of invoices and late payment enforcement when dealing with clients and business partners.
2. Credit checking potential customers to examine their chances of slowing up or fastening your working capital cycle if you do business with them.
3. Be deliberate about a better inventory management
4. Negotiate better payment terms with suppliers when taking a supply of crucial inventories
5. Make sure to step up financial awareness across all departments

How you can improve Working Capital

Having robust working capital is beneficial to businesses from several angles. Basically, it is an indication of a well-managed organization. In the same vein, it helps the management to measure the viability of their enterprise. It’s also used by banks whenever they are considering the allocation of loans to businesses.

Additionally, adequate working capital boosts the chances of continuous operation of your enterprise. Safe to say, having enough working capital gives business owners confidence that they don’t run out of cash in the event of a mild financial disruption.

Another bright side of the availability of adequate working capital is that it gets them eligible for discounts. Businesses need sufficient capital to buy in bulk so as to be in line for amazing discounts while procuring inventories. This would definitely speed up their growth and get them to be one of the fastest-growing enterprises in their industry.

To this end, working capital directly speeds up business growth especially if it is being managed by individuals who understand how to make good use of the asset to build up their enterprise. However, they have to take extra caution if they have to take a loan to boost their work capital. This requires judicious planning in their quest to utilize it effectively.