- 27 Sep
How To Increase Working Capital
This is a short article about how to increase working capital within your business.
What Is Working Capital?
Working capital (WC), in financial terms, is the amount by which the current assets of a business exceed its current liabilities. Current assets, or short term assets are the:
- Cash held.
- Stock (also called inventory).
- Accounts receivable - outstanding invoices to debtors for goods or services supplied.
Current liabilities are all creditors that are due to be paid with a year.
The calculation is as follows:
- WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES
In practical terms, companies often consider their WC to be the amount of money that they have available at any given time. That cash can be used to pay for raw materials, staff wages and other overheads. Therefore, I have also provided some tips on improving cash flow below.
If current liabilities exceed current assets, that is known as a "working capital deficit" or "working capital deficiency". In such situations, a business will be likely to have cash flow problems as there is not enough cash being generated, to over expenditure as it falls due.
How To Increase Working Capital
There are a number of ways to increase working capital which are explained below. However, please note that their degree of immediate impact on the cash position of a company will vary.
- Increase profits - if the company increases its profit margin, the amount made on each sale increases. These type of changes will take time to work through into an improvement in the cash position. Increasing the volume of sales, without a commensurate increase in costs will also increase working capital.
- Inject capital - an injection of capital (equity funding) into the business will increase working capital immediately. This could be your own money, or money from an investor.
- Borrowing - taking out a loan, overdraft, or some form of receivables financing will have the effect of boosting the WC of the company quickly.
- Extending debt terms - by extending the term of current debts, so that they are reclassified as long term debts (due in more than one year), will have the effect of improving your WC position.
- Liquidate long term assets - by selling any long term assets for cash, you will boost your WC position. This could include selling and leasing back equipment, plant and machinery.
Speeding Up Cash Flow
There are a number of ways of boosting the cash position of your company, and improving cash flow. These include:
- Quicker conversion - faster conversion of current assets to cash will speed up your cash flow. For instance, reducing the time that debtors take to pay or liquidating stock will help boost your cash position. The speed with which receivables are converted to cash may be improved by good credit control, or focusing on selling customers that will pay quickly. Accelerating your billing cycle can also play a part. Not waiting until month end to bill, or introducing partial deposits could be ways of improving your cash flow.
- Choosing suppliers - that will offer you discounted pricing can increase margins and improve cash flow, also avoiding paying any late payment penalties will help minimise the cost of sales.
- Review your costs - if you review your costs and seek to drive them down as far as possible, you will again increase your margins and boost your WC in time.
- Cash held.
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