Working capital is defined as a business’s current assets minus its current liabilities. In other words, working capital is the readily available cash that businesses need to operate. Without sufficient working capital, a business could lose its flexibility in managing daily operations, as well as its credibility with financial institutions, suppliers, and customers.
A depleted working capital supply could also lead to lost business opportunities. For instance, if a competitor goes out of business and you need to expand your inventory and marketing to service their customers, your would need working capital to cover those expenses. Without it, you cannot react quickly, leaving time for another competitor to meet those customers’ demands.
Because it plays such a crucial role, generating and maintaining working capital is vital to any company’s success. But keeping a sufficient supply of working capital on hand presents significant challenges to many entrepreneurs, particularly in the early stages of business development. Fortunately, all businesses can employ several basic practices to improve their working capital.
Make sure you get paid
Making sure customers pay for the goods and services your business provides remains the most elementary method of increasing working capital. It is important to ensure that your customers have good credit history, and that they will comply with your payment terms. Therefore, entrepreneurs should practice a policy of clearly communicating their credit policies up front.
Clients need to understand the maximum amount of credit you are willing to extend, the payment terms, the deposit requirements, and the penalties for failing to comply with payment obligations. Consequently, all business owners need to know how much they can afford to lend customers without draining their working capital.
Collecting payments from customers faster is another basic method of keeping more working capital available. However, it is important to balance your interest in timely collecting with your interest in attracting sales and maintaining rapport with your customers. Billing as early as possible can help address this dilemma and help to protect you from late payments. A common fallacy among business owners is that all billing must be done at the end of the month. It is better practice to generate an invoice and bill customers as soon as goods or services are delivered.
Take advantage of business financing
Another method of maintaining adequate working capital is to avoid using your working capital to finance fixed assets, such as equipment. Many businesses still operate with an old mentality that such debts should be paid in cash. But when business owners deplete their cash supplies, they are more likely to turn to risky financial institutions and lose confidence in their ability to run their company. Instead, long-term loans offer a way to pay for assets in installments that are more easily absorbed. Additionally, businesses can often recuperate interest costs, since the availability of working capital allows them to take advantage of more business and discount opportunities.
Refinancing fixed assets that are already under a financing agreement can also generate working capital. Essentially, refinancing allows you to leverage your assets and turn them into needed cash.
In addition to financing fixed assets, long-term loans can also be used to directly increase your supply of working capital. Securing a loan to bolster your working capital supply can be viewed as investing in your company. If you lack the inventory and equipment to properly service your clients, you cannot convert those clients into accounts receivables. A long-term loan that provides you with the working capital necessary to properly serve these clients is easily recuperated through increased revenues.
Consider investing personal funds into the business
Another option for business owners to increase their working capital is to make a personal investment in the company. However, it is important to first conduct a thorough cost/benefit analysis to determine what sort of return you can expect on your investment. A personal investment is a viable strategy if the payoff in the business outweighs personal losses.
Even with a basic knowledge of how to generate and maintain working capital, it is not always easy for entrepreneurs to see how to improve their cash flow. If a business owner is struggling with maintaining sufficient working capital or wants to expand and is not sure how to generate additional working capital, he or she should seek outside assistance. Business owners seeking advice should look for companies that will provide a thorough assessment of their business model and look at key areas such as sales cycles, inventory turnover, and credit terms for suppliers and customers to help generate more cash internally, when possible.