Working Capital Optimization

Working Capital Optimization

Working Capital is the amount of liquid cash that you have in your hands while doing business. It's not a rare occurrence that your company is making big profits, having a good sales record and yet is short of working capital. A working capital deficit affects the salaries that you pay to your employees and also the payments that you make to vendors. An adversity in this can actually lead to discomfiture in the total atmosphere of the organization. CFO Services consultants can help you in protecting yourself from such a situation with their timely advice.

CFO Services has working capital improvement partners equipped with a national network of working capital improvement resources. They are experts at communicating the status of working capital of a company. They also advise the company on the different ways in which it can better its working capital.

Working Capital Comes Before Cash

Working capital has a great effect on the general financial health of a company and for start up and middle-sized companies, managing working capital is very important. Most commonly it is believed that cash is the Almighty, but if your working capital is adequate you need not bother about cash. What the CFO Service partners have observed is that many business owners don't understand that working capital is more important as cash. Consequently, working capital is the most mismanaged area of business finances. It is not that they don't understand the math of working capital or its ratios which are quite simple even at the personal checkbook stage. It's just that they don't pay much attention to it.

If there's a shortage of working capital, the cash flow will also be adversely affected due to which you'll not have enough money to run your operations, make more business investments. Ultimately this will lead to survival difficulties for the company. Hence proper management of working capital is of utmost importance. Good working capital is the key to success in the market.

Managing working capital involves complex operations. Most company heads and owners are not even aware of the importance of efficient management of working capital. Then what will they know about the complexity of the process involved in its management. Hence it is imperative that they hire the services of professional working capital managers to improve the state of their working capital.. 'Complete Business Solutions' is not a publicity slogan for us. We've actually got solutions to any kind of business problem of yours. Improving working capital of your company is one them.

Why Is Management Of Working Capital So Important?

If you still feel that why managing working capital efficiently is so important here is some more information for you. You'll not only understand the importance of working capital but also understand its complex nature. You need to be aware that working capital plays an important role in the survival and growth of the company and it does not take a long time for bad working capital to shatter the dreams of the CEO or the owner of the company. On the other hand, if the working capital is good your company soars up to great heights of success. So it actually depends on how well you manage this. Here is some theory on working capital that will clear your concept about this business aspect and allow you to understand why it's so important to maintain its health.

What Is Working Capital By Definition?

By definition in the business context working capital is the excess wealth you have when your short term assets are more than your short term liabilities. What are short term assets? Well, all that wealth that can be converted into cash in a short time comes under this. It also includes existing cash money. Short term assets include accounts and notes receivables, your short duration saleable securities, company inventory and any prepaid expenditures. Your short term liabilities are your short term debts, line in credit, short duration payables, long term debt payment installments and other accumulated expenditures.

How do you Calculate Working Capital Ratio?

In essence you can calculate the working capital ratio of your company by dividing the sum of your short term assets by the sum of your short term liabilities. This indicates the financial strength of your company and is commonly used as a test to measure the same. If this number turns out to be less than 1, it indicates that your company doesn't have enough working capital and you'll have difficulty in meeting operational expenses and also for paying up for liabilities. But if the ratio is more than 1.5 you have reason to relax because you have enough working capital that you can convert into cash to meet your liability and operational expenses.

Also known as the quick ratio or liquidity ratio, this signifies if a company can pay for its liabilities if it's liquidated by stopping operations. Always try to maintain a ratio of above 1 and at least 1 in the worst conditions.

Working Capital Ratios are not Adequate to Indicate Company Financial Health

A working capital ratio is not the only indicator of the financial health of your company. Many CEOs and company owners are misguided by this wrong concept. When they simply calculate the ratio and find that is 1 or more, they divert their attention to marketing and sales. This leads to neglect and mismanagement of the working capital which might fall in ratio eventually. Working capital management is required for constant monitoring of the working capital and keeping it above the 1 ratio. This is done well by professionals like the CFO Services.

How Much Working Capital is Adequate?

Maintaining a healthy level of working capital for your company is not just about some mathematical calculations and result ratios. It involves some practical management. The techniques used for managing differ from business to business and situation to situation.

For managing the working capital of your company well, you should find out the key elements which affect it. These are the investment that you make in the business; the amount of inventory or the inventory worth; amounts payable and amounts receivable. These are the elements that convey the financial strength of a company and how efficiently it is operating.

You might think that excess cash signifies great prosperity. It is not always so. Sometimes excess cash signifies operational inefficiency. Keeping high cash reserves is not a point to rejoice unless you are investing it in the most beneficial manner. Is your business giving more returns for the cash internally than it would have got you if you'd have kept it externally? Instead of hoarding cash internally you can always put it in better use to improve your business, to make new business investments or for improving the business community.

How Best Do You Convert Cash?

When you get profits, probably the single best way in which you can use it is to improve your receivables account. When you are selling something on an open account you need to first buy them with cash before you sell them to get cash. This is not only true for the inventory that you buy but also for selling business services also. This conversion of cash to business resources and vice versa tells how healthy your business model is.

How do you calculate the cash conversion cycle? It is a simple process where you add up the total time taken for holding the inventory, the time taken for making your cash payments and the time taken to collect the receivables. Suppose you can hold the inventory for 90 days, take 25 days to collect the receivables and take 15 days for making your payments your cash conversion cycle is 90+25-15 which is 100 days. The carrying costs of the cash conversion cycle are added to sales price of the inventory.

Thinking of Expanding? But for a company that is thinking of expanding its sales this amount does not suffice as more money than the calculated is required to finance the increased demands. Errors might creep in, in this and this can be avoided by taking some measures. You need to keep watching some factors like Inventory Turnover, Days Sales Outstanding for the receivable and Days Payable Outstanding for payable. Improvements in these need to be made. The working capital management should also calculate the working capital for a rupee rupee of sales for the relevant industry and also for the whole supply chain.

Sales Commissions Also sales commissions that need to be given for sales improvement should also be taken into consideration., It should also include the wages and salary that needs to be given to the employees of the company.

Real world working capital management is more complex than the professional working capital management. Tax issues, Last In First Out inventory reserves, beyond balance sheet financing all add up to the complexity of the real life working capital management complexity. CFO services have got top expertise in real world working capital management as they have worked with a lot of companies in the pinnacle of growth in the business world.

Once again "Complete Business Solutions" is our motto. Its not that we are just shouting out this slogan, but that's what we've been providing for our business clients for over the years.

Please feel free to contact CFO Services for your working capital management services.