Top Ways To Increase Your Working Capital And Liquidity
Every business must opt for a proper strategy and cash flow management to ensure smooth functioning. Here, they must focus on increasing working capital. Working capital refers to the money available to a business to cover the cost of an entire operating cycle after paying its current liabilities. Businesspersons can increase working capital and liquidity by following some tips. This piece thoroughly talks about ways to increase working capital. Stay tuned!
How is Working Capital Improvement Calculated?
To calculate working capital improvement, you primarily use the formula:
Working Capital = Current Assets − Current Liabilities
To track improvement:
1. Compare working capital at different periods, like quarterly or yearly.
Improvement = Working Capital at End of Period − Working Capital at Start of Period
2. You can also use ratios like the Current Ratio or Quick Ratio to gauge changes over time and compare these with industry benchmarks.
By comparing these numbers over different periods, you can determine if your working capital and liquidity management are improving.
Ways To Increase Working Capital And Liquidity
The following are discussed certain ways or tips to improve working capital and liquidity:
Opt For Shorter Operating Cycle
The operating cycle starts when a business invests its money in several operations, which end when it receives payment. The time period gap between these activities is essential for every business. If business persons take days to send an invoice, it affects their cash flow negatively; hence they must request payment terms depending on the industry. A longer operating cycle can lead to lost income and poor liquidity; on the other hand, a shorter operating cycle can improve cash flow.
Avoid Unnecessary Expenses And Overstocking
The demands of a business are multifaceted. No wonder the expenses of a business are huge. Here, business persons along with the accounting department must spend judiciously per their business requirements and budget. They can reduce unnecessary expenses by limiting their investment in inventories. Understanding business needs, and its financial stature, i.e., the importance of working capital, can assuredly help business persons increase liquidity and invest in areas that require money the most.
Avoid Financing Fixed Assets with Working Capital
Financing fixed assets like buildings or machinery with working capital is a risky move for businesses. This approach creates a duration mismatch, as working capital is intended for short-term expenses while fixed assets are long-term investments. Moreover, short-term financing usually comes with higher interest rates, inflating the overall cost of your assets. This practice can also deplete your working capital, heightening liquidity risks and hindering day-to-day operations. Instead of compromising your financial stability, consider more suitable long-term financing options like long-term loans or leasing. These alternatives offer lower interest rates and won’t strain your permanent working capital, ensuring you can meet both your short-term and long-term financial obligations efficiently. By adopting such strategies, you can effectively increase working capital and liquidity for your business.
Perform Credit Checks On Customers
Bad debt can severely affect both liquidity and various types of working capital in a business. To mitigate this risk, it’s crucial for business persons to check the credit scores of their clients and sell products or services according to their repayment capacities, especially in the case of bigger deals.
Utilize Trade Credit Insurance
Trade credit insurance, also known as accounts receivable insurance, is a powerful tool for bolstering both working capital and liquidity. It serves as a financial safety net, protecting your business from the risk of customer non-payment. This security enables you to extend more lenient credit terms to your customers, attracting a broader clientele and boosting sales revenue. When you increase sales, you naturally elevate your working capital.
One often overlooked advantage is how trade credit insurance can facilitate better debt financing options. Typically, banks are cautious about lending against receivables due to the inherent risk. However, when those receivables are insured, they’re seen as secured collateral. This often translates to higher borrowing limits and lower interest rates, further enhancing your liquidity and working capital. Utilizing trade credit insurance as part of your financial strategy is a practical way to increase working capital and liquidity.
Focus On Timely Collection Of Invoices
A successful business runs with the help of an efficient accounting department. This department must monitor every due and focus on collecting due invoices timely. Further, they must identify accounts or persons making a late payment and continue business activities once they finish previous dues. Here, the accounting department can set reminders that will help them accelerate the collection process.
In the case of business, entrepreneurs in need of cash instantly; can release their locked cash or working capital by pledging unpaid invoices. Reputed financial services providers like KredX offer invoice discounting, allowing businesspersons to raise working capital against unpaid invoices. The invoice discounting process is quick where businesses have to sign up, complete document verification and upload invoices. Next, trusted investors will purchase the same. Once the invoice purchase process is done, businesses will receive funds in their accounts within 24-72 hours.
Find Additional Bank Finance
Building a strong relationship with your financial institution is a strategic way to enhance working capital and liquidity. Transparent communication about your business’s financial health can lead to more favorable loan terms, such as lower interest rates or increased overdraft limits. Incorporating trade credit insurance, especially from reputable providers, adds another layer of security and gives you access to valuable risk assessment data. This not only safeguards against bad debt but can make you more attractive to lenders.
In addition to fostering a healthy banking relationship, opting for tailored financial options like short-term working capital loans or lines of credit can provide an immediate boost to your cash flow and working capital. These instruments are customizable to your business needs and boost your credibility, which is beneficial when negotiating terms with suppliers and customers. By combining a robust banking relationship with strategic financing and insurance, you create a holistic strategy to solidify both your working capital and overall financial stability. Adopting such multifaceted approaches is an effective way to increase working capital and liquidity for your business.
By bringing some changes in business approaches or ways of managing working capital, entrepreneurs can take out extra funds from their operations and reinvest them. Changes in business approach mean responsible spending, careful collection, and making an informed decision. Once a business succeeds in imbibing these attitudes to their activities/operations, they can undoubtedly make the most out of their available assets and access the liquidity they need.