Introduction to Determine Your Working Capital
By definition, working capital is identified as the amount by which an organisation’s current assets exceed its current liabilities.
Arguably one of the most essential financial aspects for every organisation, experts suggest that businesses ought to maintain a working capital ratio of 1.5 or 2 at all times to smoothly operate.
This ratio especially holds for micro, small, and medium enterprises; it ensures that a business can dispense its day-to-day expenses more efficiently
With adroit working capital management, businesses can ensure their sustainability as well as gain a significant competitive edge. These factors are indispensable in increasingly ambitious market conditions.
- According to the latest government report, nearly 83.7 lakh MSMEs are registered under Udyog Aadhaar, as of December 2019. Micro and small enterprises comprise 88.3% and 11.1% respectively of India’s total MSME manufacturing output.
Numerous organisations resort to external funding to ensure optimal working capital. It streamlines the cash flow and secures a ready source of funding for the businesses to address any unforeseen requirements promptly.
- According to data published by the Reserve Bank of India, As of February 2020, micro and small enterprises received institutional credit amounting to Rs.10.95 lakh crore as of February 2020.
Nevertheless, it is of heightened significance for an organisation to determine its working capital needs precisely.
How to determine working capital needs?
Working capital acts as the financial backbone of a business. By determining how much is needed to the exact, organisations can execute its daily operations efficiently, capitalise on new opportunities better than its competitors, and accommodate changes in market demand. In brief, working capital helps companies stay agile.
Here are the few ways how an organisation can determine its working capital requirements:
Nature of business
The nature of a business is, perhaps, the most crucial factor in the determination of working capital. The amount required varies across different businesses.
- According to data sourced from Udyog Aadhaar portal, the number of micro and small enterprises stood at 83,37,708, as of December 2019.
In general, a manufacturing business requires more working capital than a service-intensive organisation. That’s because the inventory requirement is considerably more for manufacturing.
A business’s operating cycle is a critical tool when determining its working capital needs. It is the period between the initial investment (for the procurement of raw materials) and realisation of sales from debtors and accounts receivable. During this period, an organisation’s funds remain tied up, restricting further outlays.
The working capital requirement of a company is directly proportional to the length of its operating cycle. A business with a longer cycle requires more funds to keep its operations afloat and vice versa.
The scale of credit sales
Working capital requirements also differ based on a business’s volume of credit sales. Enterprises that primarily depend on credit sales require considerable working capital financing to ensure operations continue without any hindrance.
That’s because such organisations do not realise their sales’ value immediately and meanwhile require capital to fund the day-to-day operations. It applies to micro and small enterprises primarily, since they do not possess sufficient internal capital to mitigate operational expenses.
- Loans to micro and small enterprises increased by 6.7% between February 2019 and 2020.
Nature of credit terms also plays a crucial role when determining how much working capital a business needs. For instance, a company can extend credit sales to all its clients, or offer such provision to a handful of customers only. The period for which such credit is extended can also vary.
If an organisation extends credit to all its customers for a maximum period of 90 days, its working capital requirements shall be considerably hefty. On the other hand, a firm that only allows credit sales to a handful of clients and that too for 15 days maximum will have a lesser working capital requirement.
Some inventories are slower to move than others. Stocks of this nature can tie up necessary funds. Hence, businesses that deal with inventories with a prolonged turnover require higher working capital. Organisations with inventories moving at different paces should optimise their working capital management accordingly.
In that regard, a Flexi loan is an ideal avenue to meet working capital needs. Entrepreneurs can avail funds at any time from the sanctioned amount. Moreover, with this credit facility, borrowers only incur interest on the amount they utilise.
Specific businesses note a higher demand during certain seasons. For instance, an enterprise selling apparels will witness higher demands during the festive season as well as the wedding season. In order to address such a growth in demand, businesses require an additional influx of working capital.
Must Read: Other Finance Related Articles
Several enterprises opt for a business loan to defray such expenses. It allows businesspersons to meet the additional expenditure without incurring a substantial toll on their finances at once.
Such credits are offered by both private and government-backed lenders. Reputed financial institutions like Bajaj Finserv also provide pre-approved offers, which simplify and expedite the application process. These offers are available on business loans, personal loans, credit cards, etc. Individuals can provide their name and mobile number to check their pre-approved offer on loan.
Apart from the aforesaid factors, organisations shall also consider contingencies like changes in prices or demand of products to determine working capital needs. Proper working capital management is a critical determinant of a business’s growth.