Availability of working capital is necessary to keep the business going.
I started this series with Working Capital Management in Small Business (Part 1). This is the continuation of the topic. With the understanding that working capital is the difference between current assets and current liabilities, it becomes easier for you to come up with strategies on how to improve your working capital. We shall look at some elements of current assets and current liabilities and how you can manage them so that you can maintain positive cash flow.
- Inventories: What constitutes your inventory will largely be determined by the nature of your business. While some business, especially manufacturing or retailing, will have a very large inventories, service oriented businesses will scarcely have any inventories. Inventories of manufacturing company will include raw materials, Work in Progress, Finished Goods, Spare parts which are used for routine maintenance. For retailing business, goods held in shelves for sale will constitute the inventories. To ensure that you have good cash flow, you need to determine the stock level that will be appropriate for you. This is necessary as you need enough inventories to guarantee that production is not disrupted. You should guide against stock out so that goods can always be available for customers. At the same time, your inventories should not be too high so that cash which could have been used for other purposes are not tied down unnecessary. Having excess inventories will not only tie down your capital; some of the items can also perish or become obsolete. Factors you may need to consider in maintaining optimum stock levels include:
- Usage of such item in term of quantity and frequency
- Lead time – the time from ordering to the time of delivery
- Replenish interval
- Ordering costs
- Nature of the stock items and the danger of their perishing or becoming obsolete
- The reliability of suppliers
- Rumours of a shortage or an increase in price
- Receivables: Selling on credit is almost inevitable in business. When you sell on credit, it means that the customer will not pay immediately. The date for making the payment will depend on the credit term you agree with the customers
- Cash and Bank Balances: In managing capital, this is one area people focused on the most. They look at the amount of cash they have at hand or in their bank account. Having a lot of money does not mean that you should spend it uncontrollably. There is need for adequate planning and prioritization. Misapplication of funds can create a crisis for a business. For example, if you use the money that is meant for the replenishment of inventory to acquire fixed assets such as motor vehicle, there will be problems. This is what is called mismatch of funds. When you have excess working capital, you can invest it in short term investments. The returns from these short term investments will improve your bottom line. The guiding rule here is that working capital should be used to finance short term assets, pay off recurrent expenditure and to service current obligations. Capital such as personal equity and loans which are available for long term use should be used in financing the acquisition of fixed assets.
- Account Payables: These are your obligations to your suppliers. In managing your working capital, you must be able to negotiate with your suppliers so that they can allow you to buy goods on credits. Before you can be allowed, the suppliers must have found you trustworthy. You should be a man or woman of integrity. Suppliers may require that you provide references so that they can conduct background checks about your credit history. If the suppliers are convinced, they will allow you to buy on credit. This becomes a cheap way of accessing funds for the operations of your business. To continue to enjoy this, you must keep to the credit terms.
- Bank Overdraft: There will be a period of cash shortage and you quickly need to access short term funds to meet pressing obligations. Getting bank overdraft may be the way out. Any time you obtain overdraft from the bank, ensure you use the funds for the intended purpose. I strongly advise that you should not cultivate the habit of using overdraft to finance operational expenses. Instead, you should try as much as possible to collect your money from the customers. Overdraft usually attracts high interest rate.
- Tax Payable. Tax is your obligation to the government. Remitting different taxes at due dates is the best way to go but taxes can serve as temporary source of finance at times. For example, you can defer the payment of your company income tax by up to six months after the end of your accounting year. Taking advantages of timing difference between when you collect cash and when you eventually pay to the government is part of tax planning. You may need to consult with a tax practitioner for good tax planning.