A Working Capital strategy involves monitoring an organisation's assets and liabilities to ensure cash flow remains sufficient. Managing Working Capital involves observing three ratios, outline below.
Having enough Working Capital can make or break your business. How you manage it directly impacts your operational cash flow and your profits.
COVID-19 will have, in some way, impacted your working capital. Below, we will look into the benefits of a Working Capital strategy and how you can implement one.
Types of Working Capital Management Ratios
Below are definitions of the three ratios involved with Working Capital:
- The Working Capital ratio: Calculated as current assets divided by current liabilities. This is a key indicator of a company's financial health, as the figure outlines whether an organisation can meet short-term financial obligations. Depending on the industry, numbers can vary, but as an example, if the ratio is below 1.0, this suggests a business is struggling to meet short-term obligations, and any debt could not be covered by by liquid assets. At this point, a business would need to seek other financial options to cover short-term obligations, like asset finance for example.
- The collection ratio: The collection ratio refers to an organisation's ability to manage its accounts receivables. It provides the average number of days it takes for a company to receive payment after a sales transaction on credit. So the more effective your invoicing or billing department is at collecting payment, the lower the ratio is. This indicates a healthy cash flow.
- The inventory ratio: The inventory ratio relates to how rapidly a company's inventory is being sold and restocked. A lower ratio here indicates high inventory levels, while a higher ratio could indicate inefficient inventory levels that should be reviewed.
Benefits of having a Working Capital Strategy
Implementing a Working Capital strategy contributes to improving your cash flow and profitability. Benefits include:
- Ensuring liquidity
- Evading interruptions in operations
- Enhancing profitability
- Improving financial health
- Value addition
6 tips for Working Capital Management Strategies
Our team has over 30 years’ experience in managing cash flows and building Working Capital solutions.
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