Every successful business owner will tell you that ‘cash flow is king’ and effective working capital management is essential for any successful business to survive, as it provides a business with the cash flow to fund its day-to-day operations. Working Capital can be funded by the business itself or by external funders.
Analysis of the working capital cycle
You have often heard the terminology working capital, but what is it exactly? Simply defined, it is the measure of the funding that is available for a business to perform their day-to-day operations.
“Even though Working Capital and the management thereof is essential for every business, it is one of the most difficult business challenges to solve for any business owner,” says Mike Naidoo, Head of Specialised Finance at FNB Business.
Naidoo explains that a useful tool in determining a business’ working capital needs is through the analysis of the working capital cycle, which is the amount of time it takes to turn the net current assets into cash flow. The longer the cycle is, the longer a business is tying up capital in its working capital cycle without earning a return on it, which is detrimental to the owner/shareholders of the business.
Maintain financial commitments
He further adds that a successful business is one that strives to reduce their working capital cycle by reducing the number of days it takes to collect debtors or by stretching the terms provided by creditors – In both instances, these result in a business with more cash flow. When the working capital cycle is effectively managed, it will support the business’s growth; help manage a good credit record and maintain the business’s financial commitments. If the working capital cycle is not managed effectively, it could be a major contributor to business failure.
Lower ability to generate cash
According to the 2015 PWC Annual Global Working Capital Survey, SMEs have significantly higher Net Working Capital percentage than large corporations and the gap is widening. This indicates that smaller companies are less effective at working capital management compared to large corporations. It also notes that SMEs need cash more than large corporations; due to a lower ability to generate cash from operations, the higher cost of debt making cash more expensive and additionally that SMEs tend to have their return on capital lagging behind.
Enhancing business growth and reducing costs
The working capital cycle constantly evolves as businesses worldwide strive to become more efficient and cost effective. Business owners need to ensure that the solutions utilised by their businesses are effective in enhancing business growth and reducing costs.
Naidoo concludes that businesses are influenced by technology, globalisation, business efficiencies as well as suppliers. These factors ultimately dictate the variability of the business landscape and thus have an influence on the working capital cycle. Through the effective management of working capital and the utilisation of innovative solutions, businesses can grow at accelerated growth rates compared to their peers and expand into markets previously considered unreachable.