What is Working Capital Management? | Definition & How to Calculate

Working capital is the fund or asset a company requires to meet its short-term financial needs, whether it is paying its employees and vendors or covering daily expenses. Having enough working capital can make all the difference in building a business, which is why every responsible business will always ensure it has a sufficient working capital reserve. This is where working capital management comes into play, helping a company manage their financial health.

Table of Content

• What is Working Capital Management?
• Importance of Working Capital Management
• How to Calculate Working Capital?
• Challenges in Working Capital Management
• Strategies to Improve Working Capital Management

What is Working Capital Management?

Working capital management is a strategy that is designed to ensure a company maintain enough cash to meet its daily expenses while using its resources wisely. When managed effectively, it can help businesses pay their bills on time, handle short-term debts, and still put their funds in activities that support their growth.

There are four key components of working capital management, including:

• Cash: Keeping enough money on hand to run daily operations smoothly.
• Accounts receivable: Making sure customer payments are collected on time.
• Accounts payable: Paying suppliers on time without affecting relationships.
• Inventory: Maintaining the right balance between overstocking and shortage.

Together, these elements can determine whether a business can meet its short-term obligations or not.

Importance of Working Capital Management

Effective working capital management can make all the difference in stability and struggle for a business. Here is why it is important:

• Ensures that a company has enough liquidity to cover bills, wages, and purchases.
• Helps reduce reliance on expensive short-term borrowing.
• Ensure all operations are running smoothly and avoid delays.
• Helps companies survive any economic or seasonal fluctuations
• Improves the company’s creditworthiness, allowing it to secure loans at better terms.

How to Calculate Working Capital?

Beyond understanding the meaning of working capital management, it's also important to know how to calculate working capital. Working capital is calculated as current assets minus current liabilities. Here is the exact formula:

Working capital = Current assets (CA) – Current liabilities (CL)

To explain this better, here is an example:

Suppose a company has these CA and CL at the moment:

Inventory: ₹30,000

Accounts receivable: ₹40,000

Cash: ₹20,000

Income tax: ₹10,000

Short-term loans: ₹20,000

Creditors: ₹5,000

In this case, the working capital will be:

Working capital = Current assets (Inventory + Account receivable + Cash) - Current liabilities ( Income tax + Short-term loans + Creditors)

= (30,000 + 40,000 + 20,000) - (10,000 + 20,000 + 5,000)

= 90,000−35,000

= 55,000

So, the company has a working capital of ₹55,000, an amount it can use for its short-term needs.

Challenges in Working Capital Management

Indian businesses often face challenges in working capital management, such as:

• Company size: The bigger the company, the bigger the working capital it will require, which can pose a challenge for many.
• Economic fluctuations: Changes in the market can boost or lower your sales, which in turn can affect your working capital.
• Type of business: Some types of business, for instance, retail, may have more ups and downs compared to others, affecting their working capital.
• Poor inventory management: Overstocking or stock shortages can block cash and disrupt operations.
• Supplier issues: Delayed deliveries or strict payment terms with suppliers can put pressure on cash flow.

Strategies to Improve Working Capital Management

Here are some practical strategies to improve your working capital management:

• Check often: Keep an eye on your working capital, while also keeping track of the money coming in and going out.
• Receivable control: Offer discounts to customers for early payments or tighten credit policies.
• Manage payables: Negotiate better credit terms with your suppliers.
• Keep up with the news: Know what’s happening in the market. If you notice any fluctuations, change your plans accordingly.
• Use financing options: To manage your working capital, consider taking personal loans or business loans.

As we conclude, it is clear that effective working capital management is crucial for a business to have enough liquidity to grow, remain competitive and adapt to market fluctuations. By balancing what they have and what they owe, businesses can handle their money challenges more efficiently. Along with this, seeking support from a reliable financing institution can further help businesses maintain stability and fuel growth.

At Muthoot Finance, we offer a range of financial services, including personal loans and business loans, that can help businesses maintain their working capital. For more information, visit our website or your nearest Muthoot Finance branch.