Running a small and mid-size enterprise (SME) in Singapore is not an easy journey, especially considering the uncertain economic conditions, rising interest rates, and a looming global recession in the not too distant future.
With this in mind, SMEs ought to make smart financial decisions that could sustain and prolong the life of the business. This is where additional working capital can play a key role in your business growth.
To help you understand the importance of working capital, how it affects your business, tips on managing it and more, this article is a deep dive into everything you need to know.
Understanding Working Capital
Working capital is essential for running a business. It allows you to pay salaries and suppliers, as well as rent and other overhead expenses. It’s known as “working” because it’s easy to release funds to cover bills and expenses. This means that working capital can be accessed quickly, which is beneficial because the fund is not trapped in long-term business assets or investments.
What is Working Capital?
Working capital is a measure of a company’s financial health, consisting of the difference between a company’s current assets and current liabilities. This difference can be used to cover short-term bills that tend to be due within a year, and can also be used to fund day-to-day operations.
Current assets represent the resources a company has at its disposal, which can be used up or converted into cash within a year.
Current liabilities are debts that a company must pay in the near future. These debts can include payments due from customers, suppliers, and other creditors.
Why Working Capital is Important
Working capital provides a clear indication of a company’s financial stability. It is a reliable metric that can show a good indication of how stable a company is run.
In short, it’s not something that should be overlooked in your business finances. Below, we’ve compiled the reasons why understanding working capital is important.
Help in managing liquidity
Working capital can help SME owners better manage expenses. This makes it easier for SMEs to understand their financial situation and plan the necessary funds. Poor day-to-day budget planning can lead to liquidity problems. In such cases, the company may have to defer or borrow funds from other sources, which will have a negative impact on the company’s reputation.
Determine financial decisions
Working capital provides an overview of the company’s expenses and income. By accurately calculating daily operating needs, a company can assess its current financial position. This allows companies to make informed decisions about where to get funding and how much to allocate to each area.
Working capital as short term profit
When a company has more money than it needs, it can use this information to estimate its working capital situation. Beyond that, the company can consider investing funds for the short term and earning a return on those investments.
Cash flow changes throughout the year for many SMEs, depending on the season. Almost all businesses require additional working capital to meet their obligations to suppliers, employees, and the government while waiting for payments from customers. Working capital can help improve your business in a variety of ways.
Working Capital Formula
Different industries may have different working capital needs. For example, some sectors with longer production cycles may need more working capital to cover unexpected costs, while other retail businesses that interact with thousands of customers per day can often get by with less working capital.
To calculate its working capital, a company subtracts its current liabilities from its current assets.
The formula is shown below:
Working Capital = Current Assets – Current Liabilities
The working capital formula can help us understand a company’s short-term liquidity and ability to pay off short-term liabilities. This is an important metric for financial analysis, financial modeling, and managing cash flow.
A positive working capital calculation indicates that the company’s current assets are greater than its current liabilities. This means that the company has enough resources to cover its short-term debt and there is residual cash should all current assets be sold.
A negative working capital calculation means that the company’s current assets are not enough to cover its current liabilities. This indicates that the company is experiencing short-term financial problems and may not be able to meet its debt obligations in the near future.
Example of The Working Capital Formula
Take Company A for example. Company A is able to increase working capital by selling more products. When the price per unit of product is $1,000, with $600 for cost per unit in inventory, Company A will gain working capital by $400 for every sold unit. It increases either cash or accounts receivable.
By looking at a company’s working capital compared to its competition, we can see how well it’s doing and how much money it has to invest in its growth. If Company A has a working capital of $40,000, while Companies B and C have $15,000 and $10,000 respectively, Company A is in a position to invest more on growth prospects compared to its competitors.
Tips To Manage Working Capital
After understanding the importance of working capital and how to calculate it, you must now be wondering how to manage working capital. As a rule of thumb, good capital management leads to positive working capital.
Here are some of the ways to manage working capital effectively:
Plan for the future
By having access to clear future cash flows, SMEs can better plan for their working capital needs, whether that means meeting short-term funding needs, paying down debt, or growing the business. However, many companies struggle to identify even their current cash positions, making it difficult to have a sizeable cash buffer for unexpected costs.
Improve receivables
SMEs should focus on improving their working capital by improving their receivables. If a business only focuses on cash that it has already received, it may lose visibility on funds that are due. By mapping out aggregated receivables in advance, the business can identify high-risk items that need more attention.
Choose the right lender
A reputable lender that can grow with your business is important. Ideally, the institution you work with should offer some level of flexibility to make the lending process as hassle-free as possible. Also, you should look for a provider with a strong track record and customisable financing options to fit the unique needs of your business.
Fazz Business is one to take into consideration. Fazz Business provides financing solutions for businesses of all sizes, from SMEs to global enterprises. With ready access to extra capital, businesses can solve big cash flow gaps and expand their operations to take advantage of more business opportunities than ever before.
Final Takeaway
No matter the size of your company, keeping working capital healthy is important. Maintaining healthy working capital levels avoids disruptions and keeps your business running smoothly.
While you can’t predict every obstacle that might come your way, it’s always best to err on the side of caution and take the necessary steps to prepare. Fortunately, if you wish to extend your runway, Fazz Business is here for you.
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