A guide to working capital management

Working capital management ensures you have enough cash flow to operate and plan for the future. This article discusses why it’s important and how to make improvements.

30 June 2022

What is working capital management?

Working capital management is the process of managing your company's short-term assets and liabilities. It involves optimising your cash flow to give you enough money to cover your expenses, while also making sure that you don't borrow too much money.

What are the factors of working capital management?

There are three main factors of working capital management you need to consider when managing your company's working capital - cash flow, inventory and accounts receivable. We discuss each of these factors in more detail below:

Cash flow

As they say, cash is king when it comes to working capital management. You need to make sure you have enough cash to cover your expenses, both in the short and long term. You can monitor this via your company’s cash flow statement. If your business is suffering from cash flow problems, then you’ll need to address these issues and find the root cause as soon as possible. Some of the reasons for poor cash flow can be:

  • incorrect pricing
  • poor financial planning
  • seasonality

Inventory

Inventory plays a key role when it comes to working capital management. You need to make sure that you don't have too much or too little, as this can affect your cash flow and profitability. You should also be aware of the average length of time it takes you to sell your products. Too many slow-selling items will tie up your cash and reduce your liquidity.

Accounts receivable

Collecting payments as quickly as possible contributes to working capital management. If your customer credit terms are too long then it may impact your cash flow and put your business at risk of defaulting on payments. Using customer financing like iwocaPay means that your customers can spread payments across 3 monthly instalments while you get paid upfront every time.

How to calculate working capital management

Working capital management formula: subtract your current liabilities from your current assets. This will give you a snapshot of your company's liquidity and help you identify where you may need to improve your cash flow.

For example, if your current assets are £100,000 and your current liabilities are £80,000, your working capital would be £20,000. This means that you have enough cash to cover your short-term expenses, but you may want to increase this number if you’re planning to expand in the future.

How to analyse your working capital management?

Once you have calculated your working capital, an analysis of working capital management is important to see how well your business is performing. There are three main things you should look at:

The current ratio: measures your company's liquidity by comparing your current assets to your current liabilities. A ratio of greater than one means that you have more current assets than liabilities, indicating a healthy liquidity position.

The acid test ratio: measures your company's ability to meet its short-term obligations by comparing your current assets (excluding inventory) to your current liabilities.

The cash conversion cycle: measures how quickly you can turn your inventory into cash. A shorter cycle indicates better liquidity and a lower risk of running out of money.

Working capital loans

You can use working capital loans for lots of different reasons such as supporting expansion, debt consolidation or purchasing inventory. They’re typically used to cover the short-term and help businesses to improve cash flow. At iwoca, our Revenue-Based Loan allows you to borrow up to £50,000 for a fixed fee with no interest. You’ll pay back a percentage of future sales - so you don’t have to worry about seasonality or slower months.

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Charlotte is a Senior PR & Communications specialist at iwoca. She's been sharing news and insights about the finance industry for over three years.

Article updated on: 30 June 2022

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