Working capital is important for businesses of any size in order to properly manage liquidity. Recall that we calculate working capital as the difference between current assets and current liabilities. Because of this, businesses need to carefully manage:
|Working Capital Management||Description|
In establishing the appropriate level of cash, a business needs to make sure that it has cash on hand for daily operations in the delivery of products and services. It also needs to have cash on hand to service any short term debt that is due to be paid. There also needs to be an additional level of cash on hand to meet critical expenses, like payroll. Finally, there is also a need to keep cash on hand to take advantage of any unforeseen investment opportunities that might present themselves.
It would be easy to say that a business should just keep as much cash as possible on hand to meet these needs, but that would lead to idle cash not being properly invested in other assets to meet income goals.
|Accounts Receivable||This involves the development and delivery of an appropriate credit policy that optimizes sales to customers while minimizing bad debt expense. It is important to have appropriate processes in place to make credit decisions. It is also important for businesses to know their customers!|
|Inventory||Working capital management involves identifying the appropriate level of inventory that ensures businesses who deliver products have the raw materials and finished inventory on hand to meet the demands of their customers. They also must avoid overproduction, which increases inventory storage costs.|
|Short-Term Financing||A business needs to be sure that it has the credit available to purchase raw materials needed to manufacture products or the inventory of supplies needed to support the delivery of services. Most often businesses can take advantage of credit terms, where suppliers will offer terms for payment which may include the delivery of discounts. In the absence of trade credit, a business will want to have a working capital line of credit from a financial institution.|