In finance, working capital is a metric which shows the operating liquidity, efficiency and short-term financial health of any company. It is the amount of capital readily available to an organisation for its day-to-day trading operations.
There are two major components of a working capital; current assets and current liabilities.
Current assets -This refers to the tangible and intangible things a company owns that can easily be converted to cash within one business cycle or financial year.
Current liabilities – This refers to the debts and expenses a company expects to pay within one business cycle or financial year.
Therefore, an organisation’s working capital is calculated by subtracting its current liabilities from its current assets. It can also be calculated by dividing the organisation’s current assets by its current liabilities. In this instance, a ratio greater than 1 indicates that the current assets exceed liabilities, which is good for the business. The higher the ratio, the better.
Since having enough working capital implies that a company should be able to pay for all its short-term expenses and liabilities, effective strategies must therefore be employed in ensuring that an organisation’s working capital remains positive. Some simple strategies for managing working capital include;
- Effective monitoring of assets and liabilities to maintain steady cash flow.
- Introduction of strategies that can increase revenue and minimize costs.
- Close monitoring of working capital ratio, collection ratio, and inventory ratio.
- Effective procurement and inventory management.
- Making informed finance decisions.
- Assessing organisation’s current position and identification of the key performance indicators that should be tracked.
- Creating an achievable working capital action plan.
- Early payment of vendors.
- Effective management of debtors.
- Regular planning and reassessment of financial records.
There could also be conservative, hedging and aggressive strategies to manage working capital. The main aim of working capital management is to ensure there is sufficient cash flow to maintain the day-to-day activities of the company.