Managing working capital is the biggest challenge faced by businesses while running their operations. Many business owners feel that acquiring clients or increasing revenue can only help their business flourish. While it is partly true, what is equally important for a business to grow is how well it manages and strikes a balance between cash inflows and outflows.
The level of existing working capital available to a business is measured by comparing its current assets against current liabilities. It tells the business the short-term liquid assets remaining after paying short-term liabilities.
Working capital requirements might differ from business to business, but it is an important metric to assess the long-term financial health of a business. Effective working capital management also ensures that a business always maintains sufficient cash to meet its short-term commitments.
When working capital requirements are not managed efficiently, the business can suffer from cash flow problems, in turn, affecting its ability to expand, improve processes or even operate its operations. Therefore, a business owner needs to know how to plan his or her business’s working capital requirements effectively.
In this article, we will show you 6 steps that a business should follow to build a solid working capital plan.
Assess future fund requirements
An effective working capital plan should begin by evaluating the short-term funding needs of a business. These short-term funding needs include meeting payroll expenses, paying vendors, paying rent and taxes to the government.
The due date of cash outflows may not correspond to cash inflows, so a business owner must assess future fund requirements in order to meet various financial obligations.
An organisation might have long-term fund requirements too like acquiring new land or building or upgrading manufacturing machines. A business should aim to secure requisite long-term funding before executing a large capital investment plan.
Compute the working capital you will need
Every business should determine whether its current working capital is adequate under various growth scenarios.
To establish a reasonable expectation of growth opportunities available, the business has to consider the economy, its industry and competitions. For instance, how will the balance sheet get affected if current liabilities grew by 10%? Will the business still be able to pay salaries or rent on time?
Also, the business can perform a shock analysis by running the growth numbers above or below the expected rates. This will help the stakeholders to make a sound contingency plan for their business.
Suggested Read: 6 Tips to Rebuild Your Small Business after COVID-19
Evaluate your access to working capital and the alternatives
Businesses should review their current access to various funding sources, such as a line of credit, WC loan, account receivables, inventory, investment accounts and cash-in-hand. A business needs to ensure that these sources are sufficient to meet its strategic goals.
Many medium and large business enterprises consider holding cash and investments with at least two separate institutions. This diversification helps businesses protect themselves from losing access to credit during uncertain times.
Review your accounts receivables and payable processes
A business can employ several strategies and processes to maximise its working capital.
On the receivables side, a business can offer direct debit to customers, so the payments arrive on the scheduled date. This approach is used by the companies providing services that call for periodic scheduled payments like a utility service provider. Also, accepting credit card payments can help businesses improve their cash inflow.
While on the payable side, businesses can use controlled disbursement accounts to know every morning which issued cheques will hit its bank account that day. This will help the business maintain sufficient cash balance and maximise its working capital at the same time.
Don’t eat up cash, use borrowings or credit facilities
It is advisable for businesses to not use up the cash as they grow since a positive cash flow position improves the business’s access to capital and reduces its cost of capital as well. So, when the economy improves, and investments generate positive returns, the business will likely have access to credit at lower interest rates.
Test and update the plan regularly
Ideally, a business should update its working capital plan annually, supplemented with a quarterly or monthly financial position review to see if adjustments are needed.
For instance, if a business has downsized or has been merged with or taken over by another entity, its working capital requirements change drastically. This happens due to the changes in the level of current assets and current liabilities.
Therefore, a business should regularly access the state of the economy to test their access to credit facilities and improvise its plan accordingly.
Given the pandemic situation, many small and medium businesses are facing a lack of cash flow and are unable to manage their working capital requirements effectively. They are willing to take a working capital loan or open up a line of credit with banks or other sources. But, challenges in raising funds from formal sources have increased in this new-normal situation.
To disrupt the lending segment in India and provide capital to small businesses, Razorpay has built a product called Working Capital Loans.
Now businesses can get collateral-free working capital loans within 24 hours. The loans can be rapid in daily, weekly or monthly instalments as per the borrower’s convenience.
Just click on the ‘Loans’ tab to apply through our Razorpay dashboard, upload a few documents and receive a loan offer within 3 working days followed by a quick disbursal within a day. It’s that simple!
To summarise, while it is tough to predict the future, businesses must prepare their working capital plans and ensure access to capital when the economy bounces back to growth.
Also read: Razorpay Disrupts Working Capital Loan Processes for MSMEs