The fundamental indicator for a company’s long term growth is whether it has enough capital to meet its day-to-day financial obligations. Effective working capital management plays a vital role for any firm to be competitive and profitable. The level of working capital needs vary from company to company depending on a company’s size and the industry it is a part of. Still, the mechanism of working capital management is common to all companies.
The objective of working capital management is to ensure that a company has the resources needed to meet its operational requirements and to be able to ensure long-term growth by taking advantage of new business opportunities. Efficient management of cash available in the short-term as well as long-term is one of the lessons to be learned from the recent collapse of the market slowdown. One of the surest ways to reduce corporate risk is to have adequate levels of capital.
The first step in the process of creating a working capital management plan would be to analyze the current position of the company to determine whether its goods/services are competitive and the company has enough funds to perform the day to day operations while keeping an eye on future growth. Accomplishing this is however, easier said than done. History has been witness to numerous collective and individual blunders by extremely well established firms run by highly qualified people, the current financial meltdown being the best example.
A company’s working capital ratio gives us an insight into its investments, debts and inventory. It tells us which assets are costing the firm large interest payments, which debts are bad and how much excess inventory the firm usually carries. Its leverage ratio helps in monitoring accounts receivable and payable to see how long the company takes to collect its cash. Analyzing past overhead costs and expense trends can prove to be quite intuitive into the firm’s profitability.
Risk management is a critical component of business and must be taken into consideration for an effective working capital management plan. Every business must have contingency plans in place for different possible financial situations in the future. Risks should be categorized into both their probability of occurrence and potential loss to the firm.
A firm’s capital structure is the mix of debt and equity and plays a major role in determining the Working capital levels. Decisions on a firm’s capital structure are financial policy decisions that are made at senior levels of management. These decisions focus on the composition of liabilities and equity on the balance sheet. Analyzing a firm’s capital structure can provide information about the well-being and long-term prospects of a firm, the assets it has available and also affect how the company deploys these assets. For instance, a manufacturing company’s financial policy decisions involve discussions concerning the best possible mix of debt and equity. An insurance company’s management determines the appropriate premium volume that can be supported by a given level of policyholder’s surplus. In either case, the capital structure of the company plays a vital role in either enabling or restricting growth. Capital structure affects a company’s value by influencing both risk and return.
Successful businesses have good capital management plans in place and qualified people to manage them. Being well capitalized means having access to cash whenever the business needs it and having a good plan in place is the first step towards being well capitalized.
While working capital management is important to maintain the viability of a company, companies are constantly confronted with challenging issues that may stand in the way of the next stage of corporate growth, or may be faced with overwhelming debt obligations. In today’s global economy failure to create opportunities or failure to be consistently competitive usually results in very quick insolvency. At this critical juncture lack of adequate capital is usually a nail in the coffin. A firm should therefore strive to find creative, comprehensive and customized liquidity solutions to improve cash flow and restructure or eliminate debt.
In conclusion, I wish to reiterate that the management of cash flow plays a significant role in both the short and long-term viability of any firm but the focus a firm should be well balanced between both short-term gains and long-term growth particularly during today’s tough economic climate. Without cash, a company cannot perform its operations nor can it make growth plans, and it may find it difficult to take advantage of business opportunities or get credit.