Changes in working capital are quite common in the business world. Such a change is best defined as the alteration to net working capital between accounting cycles. Net working capital is equal to the difference between existing assets and existing liabilities. Every business manager is intent on minimizing upward alterations to working capital in order to make a positive impact on the bottom line. The question is, what causes these changes to working capital? Let’s explain some of the top causes.
The typical business goes back and forth with suppliers before settling on a specific payment period. This length of time has a direct effect on the company’s cash on hand. Yet it is also possible for suppliers to increase or decrease prices to offset payment period terms.
A company that grows slowly won’t need to significantly alter its working capital on a monthly basis. Alternatively, a company that experiences rapid growth will require considerable working capital changes from one month to the next. Such an alteration is necessary as the company needs to spend money on additional inventory as well as accounts receivable. This spending ties up cash.
If a business tightens up its credit, the total number of accounts receivable will decrease. This policy change generates cash. Yet the credit policy alteration can also create fewer net sales. Loosening up a credit policy has the exact opposite ramifications.
A purchasing department’s decision to minimize unit costs by buying in large volumes will trigger a boost to inventory investment. This heightened investment is a means of using cash that could otherwise be spent in different areas. Purchasing in smaller quantities produces the opposite effect.
A company’s hedging strategy can create offsetting cash. As a result, the odds of unanticipated alterations to working capital decrease. Yet such a hedge will generate transactional costs that qualify as a use of cash. These costs must be considered and accommodated for in the appropriate manner.
If a business adopts a more aggressive collections stance, it will likely spike payments and decrease the aggregate number of accounts receivable. This is a quick way to get cash. A business that adopts a more conservative collections policy will experience the opposite effects.
A business that chooses to boost its inventory levels to heighten its order fulfillment rate will see greater inventory investment. Greater inventory investment requires more cash that could be used for other purposes. Reducing inventory creates the opposite effect.
If your business has experienced changes in working capital that threaten your company’s ability to grow and boost your bottom line, don’t panic. MY Company Funding can lend critical assistance in the form of business financing options such as a working capital loan. Do not hesitate to reach out to one of our friendly representatives to learn more about how we can help you cope with working capital challenges.