Working capital strategies involve planning for short-term and long-term cash flow needs, using budgets to control spending, and calculating working capital using current assets and liabilities. Different businesses require different strategies, and economic factors can also influence them. The working capital cycle and cash flow are key considerations.
Working capital strategies are plans for future cash flows for business operations. Business owners and managers typically plan these strategies for both short-term needs and long-term goals or objectives. These plans can also make extensive use of budgets, which help companies control spending and limit or prohibit future negative cash flow situations. Selecting the best working capital strategies depends on the type of business, working capital cycle, management capability, and external economic factors.
Business owners and managers typically use a basic formula to calculate working capital. This formula is current assets minus current liabilities. Both current assets and current liabilities are typically used up in 12 months or less, making them essential for measuring working capital. Current assets and liabilities include cash and cash equivalents, receivables, inventories, short-term securities, and short-term payables and loans, respectively.
Companies typically require different types of working capital strategies. For example, retail stores need strong working capital because they must have enough cash to constantly replenish inventory products. Auto dealerships typically don’t have large amounts of working capital because they use floor plans to generate long-term financing for their vehicle inventory. Businesses that need a steady cash flow will look to limit current liabilities, which often require cash payment for current assets rather than trade credit or short-term lines.
The working capital cycle helps entrepreneurs and managers determine how well their companies generate cash flow, which is a key part of working capital strategies because cash is more fungible than current assets. Inventory, Accounts Receivable, and Accounts Payable directly affect working capital. Businesses that collect or have fewer receivables, get longer periods to pay suppliers of goods and services, or sell inventory faster can improve cash flow and working capital. The opposite will happen if companies are unable to gain benefit from items, resulting in reduced working capital.
Economic factors, commonly beyond the company’s control, can also influence working capital strategies. Tight monetary policies, unavailable corporate credit, or low consumer income can focus companies on implementing strategies that conserve working capital, rather than investing this asset in the business. In these difficult economic conditions, business owners and managers will look to reduce debt and avoid increasing balances on the company’s credit line. Avoiding excessive inventory purchases or account sales can also help businesses hold onto cash and improve their working capital position. Cash flow can be more important than income generation during economic downturns.
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