Not having a working capital strategy is like trying to hit a target with your eyes closed. You may be able to shoot, but you’re very likely to miss the target. The same thing goes for businesses that do not have their business goals enabled by a working capital strategy.
Working capital seems at first to be a deceptively simple concept. The calculation is easy. Current assets minus current liabilities equals the working capital available for a company’s operations.
Current assets are cash in the bank, accounts receivable, inventory, and anything convertible to cash within one year under normal business operations. Business equipment, buildings, and company-owned land, are examples of long-term assets. They are not current assets, even if they could sell within one year since the business would stop operating after selling them.
Current liabilities are obligations that are necessary to pay within one year. This includes short-term loans and one year’s worth of payments on longer-term loans.
Sounds straightforward enough, yet there is more to this evaluation than appears on the surface. To understand the viability of any firm completely, it is necessary to delve deeper into the specifics of the current assets and current liabilities, as well as the working capital turnover.
Erosion of Value in Current Assets
Two things commonly cause the value of current assets to decline. One is the amount of uncollectible account receivables on the books. The other is the inability to sell old inventory.
A false sense of security comes from relying on accounting entries that show large amounts of accounts receivables with no adjustments for the probability of some portion being uncollectible.
And outdated inventory may show on the accounting records at an overstated value. For such old inventory that cannot sell, the proper thing to do is to liquidate it and adjust the value of the current assets down accordingly. This process is referred to as taking a write-off or a write-down.
Sudden Increases in Current Liabilities
Another concern is the possibility of call provisions in long-term financing. Long-term loans may have triggers, which create a due-on-demand situation, based on the deteriorating financial condition of an organization. When this happens, suddenly all the longer-term loans become current liabilities. This occurrence can force a company into bankruptcy.
Low Working Capital Turnover
A company experiencing low working capital turnover is not maximizing profits. For example, if working capital is tied up in inventory or in accounts receivable that are slow to collect, the working capital deployment is not optimal.
Another place working capital becomes trapped is by investment in equipment. Equipment loans can unlock this working capital so that it is available to improve the business operations.
What Should You Do?
As part of a solid working capital strategy, it is better for organizations that have sufficient revenue-generating opportunities to unlock some of the trapped working capital by taking out a
working capital loan. The cost-benefit analysis is easy to determine. If the loan allows the company to produce profits that exceed the cost of borrowing, it is a good working capital strategy.
Having sufficient working capital offsets current asset value erosion, lessens the chance of triggering call provisions in long-term loans, and allows a company to
improve working capital turnover that increases profits.
MY Company Funding helps companies of all sizes with business financing, equipment loans and obtaining a working capital loan. Contact us today by calling 740-917-4906, filling out our
online contact form or simply
applying online.
