One of the biggest challenges for small businesses is access to working capital. According to a recent survey,54% of small businesses rated smooth cash flow as their biggest concern. Insufficient working capital can cause serious setbacks as well as hamper growth.
Do you wonder what working capital is for your business?
In simple terms, it is the amount of money you have to cover short-term expenses. Without enough working capital, your business can go bankrupt —a profitable business with insufficient working capital can become insolvent over time.
Identifying the amount of working capital will lead your business towards sustainability and growth. Gauging the working capital of your business allows you to forecast cash-management and short-term financial status.
Without working capital, the company will fail to carry out business expenses, pay stakeholders or make any further investments. Therefore, you should frequently calculate working capital to see if the trend is going up or down.
Understanding the Working Capital Needs
To understand your current financial position, you should determine the working capital ratio by dividing current assets with liabilities. For instance, if your current asset’s value is $100 while the liabilities cost $50, then your working capital ratio is 2:1.
However, your total working capital lets you determine your financial capability to cover the current expenses. To calculate net working capital, deduct current liabilities from assets, in which short-term asset includes cash account, inventory, and receivables. In contrast, a liability is an amount you owe to vendors and suppliers, thus cash payable.
How to Improve Your Working Capital?
If your business is suffering from low cash flow, then here we have a few tips to improve it:
Reduce Expenses or Increase Sales:
To improve cash reserve or working capital, you can reduce your expenses to lessen liabilities and increase current assets. You can also increase your rate of sale to improve working capital that will, in turn, cover the business costs.
Lower Your Business Debts:
Refinancing your debts is an ideal way to lower interest rates and monthly premiums. You can convert bank lines of credits into small business loans, which will lower interest rates, reduce expenses while increasing profit margin.
Manage Your Inventory:
Although inventory is a part of your working capital, it is often not liquidated at its cost price. Having less inventory that you can easily turn into sales will increase profits and increase cash flow.
Sell Unused Assets:
If you’re unable to generate cash by selling off your inventory, you should consider retailing or leasing out unused items. It will also help you increase the company’s working capital.
Negotiate with Vendors:
You should review and compare various suppliers, vendors, and manufacturers to negotiate the best price before finalizing. Finding alternate vendors will allow you to search for the lowest price for the products of your choice. Reducing price will increase savings and thus improve your cash flow.
Prepare Seasonal Sales:
Rise and fall in sales throughout the years signifies the potential of growth and success. Therefore, many companies offer seasonal sales to make the most of the business’s highs and lows. You can also manage your cash flow during the low period by increasing sales rate during the peak season.
Here are four ways to use your working capital for business growth:
Bringing new employees on board is a risk vital for your business growth. Having an extra pair of hands and brains will allow you to fill orders quickly and more effectively. It will also streamline your business processes, improve sales, and enhance marketing.
However, hiring a worker requires you to spend some money before bringing in sales and improving profits. You would be required to pay salaries and other benefits from day one and thus require cash flow to cover the cost.
But before that, you would also need to invest in the recruitment process by placing job ads, making background checks, and spending time on interviews. Moreover, you will be training a new employee before he becomes a productive team member. Nevertheless, a successful hire will cost you 1.5-2.5% of the total yearly revenue.
Improve Your Inventory
The more products you backup, the higher the chances to make sales. The more you sell, the higher the chances of profit. Thus, you should always try to find ways that can help you expand your stock. Few suggestions to improve your inventory include:
- Adding a new product line that complements your business or existing inventory, such as selling belts or shoes alongside purses or phone accessories at a mobile shop.
- Increasing product choice by offering different colors, sizes, style option or any new feature
- Offering personalization options through embellishments and custom-designs
- Increasing inventory size
However, bigger inventory means increased investments as you need to spend more money on buying the stuff. This means your expenditure will be higher before you make any sales. You may also need to invest in the storage space. But you also need your customers to pay on time or have higher profit margins to cover the cost of initial investment and next orders.
If you have a bigger investment, you can enter new market places, expand to different geographical locations or move to a different sales platform. This will allow you to reach a wider customer base and find greater business opportunities. Since it requires an initial markup cost, you should be financially sound during the early years of startup.
Typically, the initial cost for expanding your business market involves,
- Translating product descriptions, instructional guides, and marketing content
- Adjusting the current content and policies to suit the regulations of the international market
- Spending on initial setup cost and maintaining cash flow
- Setting up a warehouse in new geographical locations
Even after having a substantial line of credit, entering different markets could be quite challenging. Sparing your working capital to fund new markets could be highly risky, and thus you should opt for seed funding or small business loans for financial security.
Leveling up the Cash flow
Typically, your business goes through the sale cycle with multiple ups and downs. Thus, you need a steady cash flow to cover up for the passive period. Despite efficient management, there will be times when you would need to invest in your business to keep it running.
Having stable working capital will ensure smooth business flow, allowing you to focus on new growth opportunities.