As your business grows, the more necessary your working capital becomes. Working capital is the money your business requires to function. If you don’t have enough, then your business is bound to fail. It’s a fact that many businesses that seem to be thriving are forced to shut down because they don’t have the ability to pay off their short term debts when they are due.
For this reason, it’s really important to employ effective working capital management strategies. It’s common for businesses to have the need to loan the money used to finance their growth. Based on the credit worthiness of your business, financial institutions will decide whether to grant you a loan or not. Credit worthiness is determined by two main factors: the existence and extent of your collateral and the liquidity of your business. These are reflected on your balance sheet. You can determine this by getting the difference between your assets and your liabilities.
This difference and your working capital ratios give creditors an idea of just how capable you are of paying your bills. Technically, it is your investment in current assets, including cash, inventory, accounts receivable, and marketable securities. Your current liabilities, on the other hand, are comprised of your accrued expenses, your accounts payable, and your near-term portion of loan due.
The difference between your current assets and your current liabilities is your net working capital. The term “current” means that they are to be liquidated within the period of one business cycle, which is typically a year. The management of this is extremely important for the growth and success of your business. This involves the decisions you make regarding short-term financing.
It’s all about managing the relationship between your short-term assets and short-term liabilities. It aims to ensure that you are able to continue operation with enough cash flow to meet your short-term debt and upcoming expenses. You can tell that your management is sound by your ability to convert your assets into cash that will go into paying off your bills. The ease with which you can do this is called “liquidity,” which is greatly impacted by the rate at which accounts receivable and inventory can be turned into outright cash.