Working capital management
Working capital operates as a continuous cycle.
At its simplest, a creditor provides stock, the stock is then sold on credit, creating a debtor.
In due course, the debtor pays, thus providing the firm with cash resources which are then used to pay the creditor and the surplus cash is retained in the firm.
Firms can increase their financial efficiency by minimising the length of time this cycle takes.
A firm that reduces its working capital cycle will reduce its working capital levels.
However, there are practical, operational and commercial limitations on how low working capital levels can fall without adversely affecting operations and relationships.
As a result, the management of working capital is essentially a compromise between levels high enough for smooth commercial operation and safeguarding reputation, and levels low enough to be financially efficient.
- Working capital win-wins?
- "Effective working capital management (WCM) is a complex balance between supplier and customer relationships, operational needs, financial efficiency, and reputation.
- Simply defined, working capital is the surplus of our inventories and customer receivables, over our supplier payables. We bear the cost of giving credit to customers. Collecting money more quickly from customers reduces our financing costs, but may have adverse effects on sales volumes or prices.
- When suppliers give us credit, that helps us and costs them. Paying suppliers more slowly also reduces financing costs. But it risks damaging relationships. It also risks adverse pricing from suppliers, and even damaging our reputation.
- Intermediaries, supply chain finance and other solutions can provide win-win outcomes to some of these problems."
- ACT eNewsletter, November 2019.