At some point in time, almost all small businesses access their short term assets and short term financing to conduct daily business. This controlling and overseeing of these assets and liabilities are defined as working capital management and is an essential part of the financial management of the business.
Working capital is calculated by subtracting the current liabilities from the current assets of a business on the day the balance sheet is drawn up. Working capital is also represented by a business’s net investment in current assets required to support its everyday business.
Types of Working Capital
Working capital frequently changes its form and is sometimes also referred to as circulating capital. It can transition from cash to inventories and/or receivables and then back to cash.
Gross working capital is the total of current assets and net working capital is the difference between the current assets and current liabilities.
Permanent working capital is the minimum amount of working capital that must always remain invested. It is typically a combination of cash, stock, and account receivables that is always locked in. Necessary for daily operations and the existence of the business, these funds are drawn from long term sources.
Variable working capital fluctuates frequently due to various factors and requirements of the business. These funds are drawn from short-term sources.
Working Capital Management Objectives
Maintaining the working capital operating cycle and its smooth operation is vital for a business to function. The operating cycle or lifecycle of a business goes from the acquisition of the raw material to the seamless production and delivery of the end products. This is one of the main objectives of working capital management.
Keeping the cost of capital to a minimum is also an important objective that working capital management strives to achieve. The cost of capital is what is spent on maintaining the working capital. It is imperative that the cost of maintaining healthy working capital is carefully monitored, negotiated, and managed.
The other main objective is to maximize ROI or return on current asset investments. The return on current asset investments. The ROI on currently invested assets should be more than the weighted average cost of the capital. This ensures wealth maximization.
Working Capital Management Strategies
The conservative strategy involves low risk and low profitability. With this approach, the permanent and the variable working capital are financed from the long-term sources. eased cost capital. While the risks of interest rate fluctuations are significantly lower, the is an increase in cost capital.
By taking higher risks, the main goal of an aggressive strategy is to maximize profits. With this approach, all of the variable working capital, part or all of the permanent working capital, and occasionally even the fixed assets are funded from short-term sources. An aggressive effort to maximize profit results in lower cost capital and significantly higher risks.
A moderate strategy, sometimes referred to as hedging, involves moderate risks and moderate profitability. With this approach, the fixed assets and the permanent working capital are financed from long-term sources while the variable working capital is sourced from the short-terms sources.
Working Capital Shortfall
No matter what type of business you have or what capital management strategy you implement, your business may experience a working capital shortfall. It could be an equipment failure, lack of inventory to fill a big order or to bridge the gap between invoicing and collection. When this occurs, your business will need additional working capital fast to keep the lifestyle of the company running smoothly.
CFG Merchant Solutions offers many different options to help your business survive a shortfall. We service small to medium-sized businesses that intend to use working capital proceeds in order to grow their business.
Whether your business is looking to purchase inventory or equipment, bridge seasonality, support expansion, or invest in marketing and advertising, CFGMS can cater a working capital solution that meets those needs.
We know how to quickly and effectively facilitate a transaction, from application through funding, in order to meet our customer’s unique working capital needs. Contact us and together we will find the right solution for your business.
