Working Capital
In financial terms, Working capital is considered to be a very important factor when it comes to measuring a company's financial status, its liquidity, and its efficiency. Working capital, in simple terms, can be understood as the difference between company's current assets and company's current liabilities. Working Capital Ratio that is computed as Company’s Assets divided by Company's liabilities can give you a rough idea about company's status in the market. Generally, a ratio below 1 is considered to be bad for a company, a ratio between 1.2 and 2 is considered to be great. More is the working capital; more the company is doing good in financial terms but of course up to a certain limit. Since, when a company has more than double liabilities in comparison to assets, it is considered that company is not investing enough, but then if we are talking about a very big number it wouldn't matter now, would it?
Working capital works annually that is working capital is computed every year. It is measured keeping in mind the cash, inventory, accounts payable, accounts receivable and debt's of the year into consideration. Nothing before and after that affects the working capital. This number can help a company manage its cash and other assets.
Now, we know that working capital has its own importance; you also need to understand that this number should be kept high in order to maintain your company's financial status. There are two factors, namely inventories and receivables (company's assets) which can help you increase and maintain your working capital or better they should be kept in check to maintain the financial status of the company.
Inventories, a company’s asset are related to the production of a company's goods and services. They include products under manufacturing as well as products out for sale. Also, consignments (to be received by the company) come under Inventories. Basically, inventories include raw materials, under production as well as finished goods. To increase working capital and profit, you need to minimize the inventory expenses as much as possible keeping in mind the quality of the product. Inventory management shares a big space when financial statements (balance sheet) are penned down. Finding the best way to produce, store and move your inventory can make a huge difference. These inventories further help companies in a time of emergencies like unanticipated demand from customers or unexpected breakdown of any management or operation in the factory or workhouse. A proper inventory management is maintained by most of the companies.
Receivables generally are the ones who owe any kind of capital to the companies in short known as debtors. Receivables obviously will increase your working capital since they indirectly mean cash. Anyhow receivables should be cashed as soon as possible since they will help maintain the given credit limit as well as increase the value of your word. It will also help you maintain an easy and quick credit system without any slacks. A proper draft regarding receivables should be maintained. A debtor's background check is also suggested so as to protect your cash. Also collecting receivables, not in time can affect your working capital and disturb the cash flow cycle.
At the end, we can conclude by saying that inventories and receivables play a big role in computing working capital and you should handle both carefully in order to have a smooth cash flow.
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