Working capital is the amount available to finance a company's daily operations. It is a measure of a company's liquidity and indicates how much resources are available to pay off debts and make investments. Improving your working capital is therefore essential.
Why is working capital so important?
Working capital is an important measure of a company's financial health. It indicates how much resources are available to finance daily operations and to invest in growth and expansion. Proper working capital management can help a company maintain short-term liquidity and finance long-term growth.
Poor working capital management can lead to liquidity problems, as there may not be enough resources available to pay off debts and make investments. This can lead to payment delays, poor creditworthiness, and even bankruptcy.
How do you calculate working capital?
Working capital is an important financial ratio that indicates how much resources a company has available to meet short-term obligations. To calculate a company's working capital, you need to take the difference between the company's current assets and current liabilities. Current assets are assets that can be converted into cash within a year, such as inventories, accounts receivable and cash. Current liabilities, on the other hand, are liabilities that are due within one year, such as accounts payable, taxes, and short-term loans.
There are two ways to calculate working capital: gross and net working capital. Gross working capital is the total value of the company's current assets. Net working capital is the value of the company's current assets minus the company's current liabilities. This gives a better picture of a company's long-term working capital position, as it shows how much cash is available after paying off its current liabilities. Thus, net working capital is a better measure of a company's liquidity.
Below are the formulas for calculating gross and net working capital:
Gross working capital = current assets*
*current assets = liquid assets + stock + accounts receivable
Net working capital = current assets – current liabilities
Where:
- Current assets are assets that can be converted to cash within a year. These include, for example, inventory, accounts receivable, and cash.
- Current liabilities are liabilities that must be paid off within a year. These include, for example, accounts payable and short-term loans.
How can you improve working capital?
1. Shorten customer payment terms and extend supplier payment terms
- Customers: The faster customers pay, the better it is for a company's cash flow. It is therefore important to encourage customers to pay on time. One way to do this is by agreeing on shorter payment terms, for example, 14 days instead of 30 days.
- Suppliers: On the other hand, extending payment terms to suppliers can actually increase working capital. By taking longer to pay bills, more money remains in cash for other expenses.
2. Limit inventory levels to a minimum
- Ensure efficient inventory management. Too much inventory can lead to high storage costs and unnecessary costs for outdated or damaged products. Therefore, make sure you know exactly how many products you need and what the customer demand is. By analyzing this information, you can manage inventory levels as efficiently as possible.
- Also, try to keep the production process lead time as short as possible. This allows you to quickly respond to customer demand and prevent unnecessary inventory from remaining on the shelves.
3. Ensure efficient accounts receivable management
- Send invoices in a timely manner and actively follow up on outstanding invoices. This can increase payment speed and ensure that money comes in faster.
- Use factoring. Factoring is a way to convert outstanding invoices into immediate cash flow. A factoring company then takes over the accounts receivable risk and pays the outstanding invoice immediately.
4. Optimize your working capital
- Ensure a good ratio between current assets and current liabilities. Keep current assets as high as possible and current liabilities as low as possible.
- Analyze your cash flow daily. By doing this daily, you can quickly make adjustments when necessary.
- Maak gebruik van financiële instrumenten zoals factoring, leasing en kredietlijnen om de cashflow te verbeteren. Dit kan ervoor zorgen dat er meer werkkapitaal beschikbaar is.
By applying these tips, you can improve your working capital and ensure a healthy financial foundation for your business.
