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Why is managing your working capital important?

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Inflation, increasing taxes, and economic instability make managing working capital even more important

In an era of COVID-19, inflation, increasing taxes, and economic instability, it is more important than ever for entrepreneurs and small business owners to stay on top of the financials.  According to the US Small Business Administration, one of the most prevalent causes for small businesses failing is a lack of cash flow.  Stepping up and managing your working capital can greatly improve your financial condition.  If not, your business life can get very difficult.

Working capital for small businesses is typically a mix of cash and credit, which can fluctuate without warning. Knowing the drawbacks of poor capital management can help you take steps to protect your firm when money is tight.

What Is Working Capital, and What Does It Mean?

According to Investopedia.com, working capital is also known as net working capital (NWC). It is the difference between a company’s current assets (cash, accounts receivable/customer’s unpaid bills, inventories of raw materials, and finished goods) and its current liabilities, such as accounts payable and debts.

Working capital is a measure of a company’s liquidity, operational efficiency, and short-term health.  If a company has positive working capital, then it should have the potential to invest and grow.  If a company’s current assets do not exceed its current liabilities, it may have trouble growing or paying back creditors or even going bankrupt.

The financial ratio that best captures your working capital is your working capital ratio, which is a liquidity ratio that measures your ability to pay your short-term liabilities from your short-term assets.

Generally speaking, the type of industry you are in will determine the ideal current ratio for your business.  However, in most cases, a current ratio between 1.5 and 3 is considered acceptable, while a current ratio of less than one may indicate that your business may have some liquidity problems.

About small businesses and their current ratio, small business owners should focus on the amount of cash and credit they have available while keeping an eye on accounts payable due shortly to manage working capital successfully. Consider working capital to be the money you have to work with.

If you have problems with your working capital, the following can happen:

You can lose suppliers

Even if you pay your vendors and suppliers ultimately, if you pay late regularly, they may cut you off from the supplies you need to maintain your business. Your suppliers will be more likely to hunt for substitute consumers if they are tiny. Even if they wanted to, they might not be able to sell to you at that point.

You may not be able to pay your bills

You can’t pay your bills if you don’t have enough operating capital. This can result in legal issues, such as the seizure and closure of your company. It’s critical to have credit sources available to assist you if you run out of cash. Credit cards, loans from family and friends, bank loans, and lines of credit are examples of these.

Your customer’s orders may be late

Customers may not be willing to wait if manufacturing and delivery of your products or services are delayed due to a shortage of working capital. Consumers have many options and choices in today’s need-it-now business environment. Customers who test a competitor’s product or service are more likely to stick with that company, leaving you for good. You’ll have to spend time and money at the very least trying to get them back.

Your employees may not get paid

Although your employees may not quit working for you the first time you delay their pay, you’ve delivered them a message that the company is in peril. This lowers morale and raises the risk of misinformation spreading in the workplace, leading to personnel departing for greener pastures.

You may not get paid

Another downside is that you may not get paid, or your take-home pay may be reduced. Responsible small business owners and entrepreneurs are the last to be paid.  As a result, you may need to hunt for new work, sell a portion of your business to an investor, or reduce your hours and release employees, depending on your situation, if you have a working capital shortfall to cover.

Take steps to increase your working capital

Take efforts to alleviate cash flow issues if you’re having trouble. To bring cash in faster, you might reduce your accounts payable terms from 30 to 10 days. Pay down debt to lower interest payments if you have excess cash in your account for several months, but make sure you have enough money on hand to manage emergencies, should they arise.

Wrapping up managing your working capital

The best thing you can do managing your working capital is maintain a current balance sheet for your business and monitor your current ratio.  Try to keep your current ratio positive and in the range of whatever you determine is adequate not to experience any of the scenarios previously described.  Another benefit to managing your current ratio is that lenders will want to see your assets and liabilities before extending credit to you.  The stronger the financial situation you can present, the better you will look.

If you don’t have sufficient working capital to cover your short-term liabilities, look to sell off some assets to cover your shortfall.  If you don’t have anything, consider a working capital loan.  We are a small business lender with a working capital loan, being just one tool in our tool kit to help small businesses reach their goals.

Whether it be working capital financing, an equipment financing, or a merchant cash advance, we can help.  Contact us today to discuss your small business financing needs at (800) 795-3919

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