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Working capital management is critical to profitability and maintaining a positive cash flow for any business that seeks sustainability, growth, and development. In technical terms, working capital is positive when the assets owned by a business are more than the liabilities. Negative working capital may result from having higher liabilities than assets. Activities such as high-value purchases or investments by a business can affect working capital temporarily, causing it to go negative for a short period, till balance is restored.
Working capital management is essential for businesses, especially startups and small to medium sized entities. It ensures businesses do not run out of the money and assets required to operate the business.
A very high number of assets may mean positive working capital, but could be interpreted as a business not managing its assets well enough to translate into financial gains. On the other hand, negative working capital for an extended time may indicate that the business may not be sustainable.
Working capital management is important for businesses to track and monitor regularly to ensure there is adequate cash available at all times.
The Connection with Cash Flow
Cash flow is the measure of actual cash available in the company. Any changes in cash flow can influence the working capital that a business owns.
Maintaining positive cash flow is vital to ensuring adequate working capital. A negative cash flow indicates more money is locked in receivables or dues. Negative cash flow also means that there is not enough liquid cash for operations. A positive cash flow translates into increased working capital.
● In business terms, cash flow indicates presence and availability of cash, whereas working capital is about assets owned by the business or liabilities it has.
● Any change in working capital reflects in the business’ cash flow statement. Purchase of an asset such as property or premises can be recorded as a decrease in the cash flow statement. Working capital also decreases because the cash component of current assets owned by the business would be reduced.
● Consistent management of working capital helps track business assets at any given time, but cash flow must be analyzed as well when determining financial health over the long term or short term. For example, long-term debt may prove to have a negative impact if it does not result in the business generating significant income and cash flow. On the other hand, a large purchase or investment that leads to reduction in cash flow may be a good decision because it has the potential to generate higher income for the business.
Why Streamline Accounting, in the First Place
Working capital management is an accounting and bookkeeping function that contributes to the financial health reports of a business.
Streamlined accounting and bookkeeping functions can help ensure reliable reporting on the working capital of the business. This can include multiple factors:
● Timely and accurate recording of purchases made by the business.
● Long-term and short-term debts influencing working capital and cash flow differently. In turn, these factors reflect on the financial health of the company. If long-term debt is generating revenue, it may not lead to negative cash flow. Similarly, a short-term debt may actually lead to negative cash flow in the absence of any revenue generated.
● Poorly-maintained records can lead to incorrect perceptions about the actual investments, liquid cash, and operational stability of a business.
Basics for a Strong Bottom line
The financial health of a business, including factors such as cash flow and working capital management, depends on diligent accounting and bookkeeping. Here are some considerations when working to maintain positive working capital at all times.
● Diligent bookkeeping to track collections, maintain accounts receivable and accounts payable, and ensure payment obligations are met on time.
● Optimization on obligations such as tax payouts and applicable credits, especially if your business structure allows you to take advantage of certain incentives.
● Adequate working capital to ensure operational efficiencies as well as available cash for any immediate business purchases.
● Not tracking working capital or cash flow can result in unavailability of funds when needed most.
Leveraging professional assistance for accounting services can take care of working flow as well as cash flow management. This is especially helpful for growing businesses that must also pursue new business opportunities and newer lines of revenue generation without impacting existing financial obligations.
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