WORKING CAPITAL MANAGEMENT PART 2
In our previous article we covered the components of Working Capital. In this article, we will cover Working Capital Management. Working Capital Management is a important strategy every business owner should carefully consider. The goal of working capital management is walking the fine line of balancing Current Assets to Current Liabilities ideal to the business you run.
Working capital (WC) can be managed in broadly two ways:
Managing the Current Assets/Liabilities
Financing the Current Assets
Companies can borrow short term loans to fund their WC requirement, but this would increase the financial debt for the company and put strain on the profits as well. The ideal situation should be that the company manage the current assets/liabilities and borrow only when and if required.
Managing the Current Assets/Liabilities
Companies can deploy strategies to effectively manage current assets and liabilities. Careful monitoring needs to be in place with timely review so as to not have any surprise events.
Cash management is one of the most critical elements of working capital management. Idle cash doesn’t earn any returns for the company. Companies need to determine the appropriate amount of liquidity levels to maintain through planning and budgeting and should periodically invest the balance in short term or liquid investments. This would be possible through careful study of expected cash realizations and payments.
Receivable generally contribute to a large chunk of the current assets and usually is a pain point for many companies.
As a good practice, companies should send invoices on time.
Also, make sure the credit terms with your clients are not too high.
If the company is an MSME and has a Udyog Aadhar (as explained below), companies can make a disclaimer in the invoice stating they hold a Udyog Aadhar, which would imply that the client has 45 days to make the payment.
Companies can also use various financing measure like bills discounting, factoring and also use platforms like TReDS.
Excessive inventory can place a huge burden on the cash and inefficient inventory holdings can put pressure on margins and sales. Also, Prices and availability of inventory in certain industries can be volatile depending of the nature of the product. For example, gold prices, raw materials that use petroleum by-products, commodity prices etc. Sometimes companies can also be tempted to buy excess inventory when the price is low and vice versa.
To mitigate such risks, the company can:
hedge the product prices by entering forward or futures contracts
assess inventory requirement based on budgets & trends
have a appropriate supply chain management in place
dispose slow moving stock
outsource part manufacturing if it is more cost effective
Companies can also use non-fund limits wherever possible.
Companies should pay vendors on time which would promote and develop better relations with them which would eventually lead to better negotiations for deals, credit periods and payment terms and also get discounts.
Funding Working Capital
Companies can use various funding options available which suit their requirement. Funding should only be a temporary solution since funding has various costs associated with it which in turn affect your profits and balance sheet.
Udyog Aadhar is a self-certified online application which is basically an identification system similar to Aadhar but specifically for MSMEs to promote business growth. As a owner of Udyog Aadhar, as an MSME in case there is a delay in payments by the buyer, the buyer is liable to pay compound interest with the monthly rests to the supplier on the amount at the three times of the bank rate notified by RBI in case he does not make payment to the supplier for his supplies of goods or services within 45 days of the acceptance of the goods/service rendered.
For more information , refer : https://udyogaadhaar.gov.in/UA/UAM_Registration.aspx
Working Capital Loan
This loan is to fund the working capital gap (Current Assets-Current Liabilities) to fund the day to day and short-term liabilities. This loan is provided by most banks/NBFCs/FIs which could be collateral free as well.
Bill discounting/factoring is a process where companies sell their invoices to financial institution before maturity and at a price lower than invoice value.
TReDS is a digital platform approved by the Reserve Bank of India (RBI) facilitating financing and auctioning of trade receivables of MSMEs from Corporate Buyers and other buyers. Banks and financial institutions are the financers. The loans on this platform are without recourse – i.e. the MSME is not responsible if the buyer does not pay against the invoice. This is source for lower rates of interest since it depends on the buyer’s credit profile.
The 3 TReDS platforms are –
M1xchange - https://www.m1xchange.com/
Invoicemart - https://www.invoicemart.com/
In conclusion, Working Capital Management should form an important part of any company’s long term strategy to work towards being a financially efficient company.