What You Should Know About Net Working Capital
Your working capital determines your company’s liquidity, which is its ability to pay its current expenses. This capital directly impacts the success and financial viability of your company. Therefore, these are some things you should know.
You should know exactly how much capital you need every day, week and month. You should avoid low or negative balances in your capital accounts. If you are running low, you may need to sell other assets or offer extended customer credit to pay your bills. You should use the capital ratio, which divides your current liabilities into your current assets, to learn about your current capital, and then build strategies to expand it if necessary or reinvest overages so you get more out of your money.
Current Assets and Liabilities
Your current assets include anything that can be quickly sold. These include inventory, accounts receivable or cash. Investments, machinery and real estate are not current assets because they are not easily converted into cash.
Your current liabilities are your bills, from your operating costs to your debt service and taxes. Long-term loans are not considered current liabilities. Accounts payable are also current liabilities because they are due in full within a short period of time.
To reduce your liabilities, you may negotiate with your creditors and vendors to gain better terms on your short- and long-term debts. Short-term loans can also be used for shortages, but they should be paid off as quickly as possible. Also, avoid using them for buildings, machinery and other fixed assets. In addition, if you have to continually get short-term financing to cover your working capital, search for expenses you can cut or ways you can increase your income. If you continually require financing, you can damage your credit or become overextended and not be able to meet your short- or long-term obligations.
You should also watch your inventory. You never want the inventory to sit on your shelves for months on end, but you want enough so you can meet your requirements. You may consider a just-in-time inventory model to optimize your inventory.
Finally, collect your accounts receivable. Although these are an asset on your balance sheet, if they are not collected, they cannot help your company. Therefore, create clear payment terms. Don’t be afraid to call your customers to verify that they received your invoice, and discuss early payment discounts and late payment fees.
As you learn to optimize your working capital, your company should stabilize. You may even find that you have additional funds that you can reinvest or save for unexpected expenses.