Although they are often confused, business liquidity and working capital are two different but equally important financial factors for business success. As a business owner, it is important that you have a clear understanding of each and how to manage them. While veteran business owners may have a handle on this, improper cash flow management is what gets many entrepreneurs in trouble. Let’s start by defining working capital and business liquidity.
Working capital is defined as current assets minus current liabilities. If your business currently has $250,000 in assets and $175,000 in liabilities, your working capital is $75,000. In addition to cash, current assets include accounts receivable, inventory, and any short-term investments. Current liabilities include accounts payable, short-term loans, and other accrued expenses such as payroll or interest.
Business liquidity is directly related to your current assets and the ability to quickly turn them into cash. These are considered liquid assets. Liquidity allows you to pay current liabilities when they come due. Not only is it necessary for a business to continue daily operations but to promote growth.
When a business has enough cash or liquid assets to pay all of its current liabilities, it has positive working capital. How much working capital is needed varies from business to business. The ideal amount of positive working capital will cover current liabilities with enough excess to invest in business growth. Negative working capital is when your cash and liquid assets aren’t sufficient. Liabilities become past due and the business’s ability to sustain itself falters.
To improve your business liquidity, you must first take steps to increase your working capital. There are a few different ways to do this.
This simply means you need to get your customers to pay you quicker. You can encourage this by offering a small discount for early payment. You should also evaluate your invoicing process. Customers should be invoiced immediately upon receiving goods or services. Even waiting a few days before sending out invoices means it will be that much longer before getting paid. You can also reduce the amount of past-due receivables by conducting thorough credit checks and levying late fees. You can sell invoices to a factoring provider and get funds already owed to you before the payment is due. This is known as invoice factoring and is a great way to convert outstanding invoices into cash.
When was the last time you evaluated your business operations? If your business is running inefficiently, it’s costing you money and decreasing your working capital. By streamlining business operations, you can reduce payroll expenses. You need to take a long hard look at your long-term assets. These are typically business equipment or investments that aren’t vital and could be sold.
Even if you are effectively maintaining a high level of working capital and business liquidity, that doesn’t mean your business will never experience a gap in cash flow. When that happens, you’ll want to secure funding as quickly and efficiently as possible. A great way to do this is to establish a relationship with a lender and apply for funding before the need is urgent. It’s like using a credit card not because you don’t have the cash, but because you want to build your credit. With an established relationship backed by a strong payment history, you will have no trouble securing funding when you need it most.
As previously mentioned, the health of your working capital has a direct impact on your liquidity. By taking the necessary steps to improve your working capital, increased liquidity will almost certainly follow. It can help to delay the payment of liabilities until they are due and wait to invest any of your working capital in business growth until you can do it comfortably.
Maintaining your working capital and business liquidity is crucial, however, most businesses will experience a gap in cash flow at some point. When this happens, the CapFlow Funding Group can help. We specialize in invoice factoring and can help you determine if it is the right option for your business. We are dedicated to helping our clients find the best funding solution and can also connect our clients to options such as purchase order financing, inventory funding, and merchant cash advances. We service many different industries with a variety of funding needs. Contact us today or apply online. Get the cash you need to keep your business moving forward.
Effective working capital management is at the crux of every successful business strategy. Without enough capital, not only will a business have to pass on growth opportunities but they could end up struggling just to cover daily operations. Consistently maintaining positive working capital can be the difference between success and failure – especially during an economic downturn. However, even when the economy and business are good, working capital management is vital to keep your business moving forward.
Simply put, positive working capital is what a business has left of their current assets once their current liabilities have been satisfied. Proper working capital management provides important benefits.
Maintaining a high level of working capital ensures that a business has sufficient cash flow. This will allow them to not only cover the expense of their daily operations but also to take advantage of unexpected opportunities or handle unanticipated expenses.
Improved liquidity gives the business the ability to prevent disruptions to its daily operations. Fewer disruptions increase production which in turn, keeps the business operating at a high level of efficiency.
The accounts receivable and accounts payable departments of a business play a key role in maintaining sufficient working capital. Encouraging the timely payment of receivables can prevent a gap in cash flow. This will provide the ability to satisfy accounts payable early, receive any early payment discounts, and avoid late payment fees.
Although surviving the economic downturn caused by the recent pandemic was tough, it opened many business owners’ eyes to the need for improved working capital management. Not only will it make things easier when business is good but having sufficient working capital when the unexpected strikes will make the road to recovery easier. Here are some tips to ensure your business is maintaining sufficient working capital.
Maintaining the proper inventory level is vital in preserving your working capital. However, achieving the ideal inventory level can be reminiscent of Goldilocks’ visit to the home of the three bears. Keeping too much inventory on hand will ensure you can meet customer demand in a timely manner. It can also tie up your working capital, reducing your liquidity. Too little inventory can result in the failure to meet customer demand, causing your customers to seek out your competitors. Analyzing previous sales and creating future sales projections will help you determine the proper amount of inventory to purchase to meet customer demand and preserve working capital.
During the height of the pandemic, you may have been more flexible with your accounts receivable. Now is the time to require your customers to return to your original payment terms. You should also evaluate those terms. Can you shorten the time between invoicing and the payment due date and still retain your customers? Or offer a slight discount for early payment? This could significantly decrease the possibility of a gap in your cash flow and improve your working capital management.
Tightening up your receivables process and improving your cash flow will allow you to pay your vendors faster. On-time and early payment can strengthen vendor relationships and result in receiving better deals, payment terms, and discounts.
Even with the proper working capital management, a business may still occasionally find itself in need of some additional capital. CapFlow Funding Group may be able to help. If your business needs an immediate, short-term influx of capital to keep your business moving forward, alternative merchant funding options can be a great solution.
At CapFlow Funding Group, our team of professionals will evaluate your unique situation and help you determine which funding option would best suit your company’s needs. We service many different industries with a variety of different funding needs. In addition to merchant cash advances and invoice factoring, we work with trusted partners to provide additional merchant funding options. Contact us today!
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