Working capital is defined as the capital used to run the daily operations of your business. In terms of the formula, it is calculated as the current assets minus the current liabilities.
Some of the current assets include cash, inventory, short-term investments and payments yet to be received from the clients. Generally, significant current liabilities are bills, salaries and business loans. If your current liabilities are more than your current assets, then the funds need to be sourced to meet the working capital needs.
The working capital ratio reflects the company's liquidity and cash flow status. It is derived by dividing current assets by current liabilities. When you borrow funds for your company's growth, the lenders assess if the company has enough liquidity to repay the debt. It is important to maintain a healthy liquidity ratio for the successful operation of your business.
Let’s see the steps that your business can take to never run out of working capital
Timely payment by clients is important for maintenance of your current assets over and above your current liabilities. Make sure that you have received all the payments from your clients. While cash on delivery may take time, payments through online means are faster modes of payment.
To keep a track of your invoices and customer payments, maintain a regular bookkeeping discipline. A digitalized accounting system leaves less scope for lapses in tracking of payments. You can even choose an ERP system for more real-time updates.
Additional read: Commonly asked questions around working capital loans
Keeping track of defaults by customers is critical when it comes to maintaining a healthy working capital ratio. Identify customers who regularly default and avoid working with them. You can resort to upfront payments as a business strategy. Clients who can have genuine problems can be issued invoices in parts. The focus should be on the reduction of the defaults.
Balance your credit terms
If the customers pay you in 15 days and you have to pay your suppliers in 10 days, it may lead to a negative cash flow. If there is not enough business income, the working capital cannot be financed. If your trade credit does not suffice, you can choose factoring to balance your credit terms. Factoring is a system where you get short-term cash against the value of the invoices you have issued.
Additional read: Everything you need to know about the life cycle of working capital
Manage your profits
To maintain adequate cash flow, you need to make sure that the stream of profits does not dry up. In the event of lack of business earnings or losses, the daily operations will eat into your cash reserves and negatively affect the working capital ratio of your company.
Adoption of an aggressive marketing strategy can help you to boost your sales. You can project your cash flow based on the business earnings and it will help you understand when the cash flow comes in, and how to use it to manage expenditure.
Increased sales would require more inventory, manpower and other resources. The business earnings may not be immediately available to support business expansion or even daily operations. The working capital needs can be funded by the business net income, sale of fixed assets, equity financing or debt borrowing.
Businesses can avail collateral-free Flexi business loans to meet the financial goals at nominal business loan interest rates. These flexible loans offer a pre-determined loan limit for a set tenor, and a pre-decided business loan interest rate. However, you can withdraw as much is required in a given time so that you pay interest only on the borrowed sum and not the whole loan limit.
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