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Steps to Optimize Net Working Capital

Be it a company or a trading house, the net working capital is the lifeline of every business entity. A business essentially needs working capital to carry out smooth and healthy operations. Moreover, a manufacturing company requires it to run its day-to-day activities. In addition to that, in order to meet numerous short-term financial obligations, the company depends on the available working capital. 

In a nutshell, net working capital is nothing but the capital possessed by the company in the form of cash or liquid, that helps the company run its daily operations and meet current financial obligations. Every business house needs working capital, either in the form of immediate cash or just cash. Net working capital is indeed the pocket money of a business entity.

It is possible to determine the net working capital by subtracting current liabilities from current assets. Ideally, the ratio between current assets and liabilities needs to be 2.1. Such a ratio is called a healthy or balanced ratio. In order to effectively maintain this ratio, the company needs to effectively manage its net working capital. If the working capital goes below the ideal ratio, it won’t take much time for the company to get into the stage of bankruptcy. 

On the contrary, the working capital above the ratio might fetch the company’s lesser profit and ultimately, reduce its share value. In this fiscal scenario, managing the net working capital effectively and efficiently should be the motto of every business establishment. 

Before going any further, it is necessary to put emphasis on the management of net working capital and the concept of the conversion cycle. 

  1. Understanding the Cash Conversion Cycle

It refers to the time taken by a business unit to convert its current assets and liabilities into cash or liquidity. For the optimization of the cash conversion cycle, the company is required to focus on four sectors including cash/liquidity, receivables, payables, and the inventory position. After all, the better one manages the cycle, the greater would be the position of working capital. 

Shorter Working Capital Cycle

In this category, the capital takes the minimum possible time to complete the operational cycles in order to get immediately available to the company. As a result, the company can reinvest the capital within a shorter interval.

Longer Working Capital Cycle

Here, the capital of the company is stuck for a longer period in the operational cycle. The result, in turn, is a much lesser return.

Therefore, the companies running well seldom neglect the sector of net working capital. They always foster the shorter working capital cycle. To materialize, these companies focus on improving the short-term liquidity position as well as the development of operational efficiency.

To shorten the working capital cycle, certain steps like a quick collection of receivables, shorter inventory period,s and longer payment terms need to be executed. 

  1. Areas of Opportunities

Net working capital is vital for companies as it helps them procure raw materials and wage payment as well as conveniently meet overhead expenses on a regular basis. For this, companies need to regularly monitor their cash flow and strive to improve the position of their working capital. 

Sectors to Focus On

  1. Encouragement of Quick Receivables

The company is required to encourage cash on delivery systems and give incentives to the ones who deliver on time. Regular defaulters need to be discarded.

  1. Prevention of Penalty due to Delay in Payment

The company needs to meet financial obligations in time, in order to avoid paying penalties and maintain a desirable reputation. 

  1. Making purchases at Minimum

The business house needs to choose vendors who offer discounts, a longer payment period, and above all, a cheaper price. It is wise to maintain a better business relationship with such individuals. 

  1. Reduction of Fixed and Variable Costs

It is necessary to identify and eliminate wasteful as well as unnecessary expenses. With this approach, it is indeed easier to minimize fixed and variable costs up to the required level. 

  1. Management of Inventory

Finished products need to be kept in the inventory for a longer period. At any rate, quick disposal fetches a quick return.

  1. Control of Overhead Expenses

To boost the position of working capital, it is necessary to control overhead expenses and bring them to the minimum level. 

In addition to the above sectors, availing tax incentives and issuing company shares are other areas of opportunities one can have. 

  1. Prioritize Areas of Opportunity

It is a collaborative strategy and craves for multifunctional cooperation in an organization. Companies need to manage their liquidity position in the same rigor as they focus on the profit and loss ratio. To materialize this concept and enhance the position of net working capital, the company needs to prioritize areas of opportunity. 

  1. Making a list

To boost the position of networking capital, one has to initially make a list of opportunities on the basis of ranks. It is nothing less than building a road map to work further.

  1. Working on a Priority Basis

The action here can be taken immediately in order to preserve liquidity. Even without a justification, these steps free up the net working capital. Withholding supplier payments is a relevant example of it.

  1. Initiating Required Action

In this approach, either minimum process or system change is adopted to gain sufficient net working capital. Steps to get a quick return on the sale of slow-moving inventory is an example for it. 

  1. Action with Careful Consideration

It is nothing but, teamwork and requires a multifunctional strategy. To improvise the net working capital, vital system and process change activities are executed in this case.

  1.  Tracking Net Working Capital Initiatives

It is a quality control and performance evaluation step. The increase of networking capital glides through three significant phases – developing the list of opportunities, initiating required actions, and finally, tracking and monitoring the progress. To materialize this approach, the involvement of senior leaders, as well as field staff and other personnel, is important. 

At any rate, making the policy on initiatives isn’t sufficient, it is important to make a proper implementation. Know more details from the Experts Contact Dodder & Co.

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