What is working capital?
As an entrepreneur, you face various financial obligations daily. To meet these obligations, it is essential to have sufficient working capital. But what exactly is working capital, why is it so important, and how do you actually calculate it? We cover it in this blog!
What exactly is working capital?
Working capital is the money you need to pay day-to-day financial obligations. For example, you can think about paying salaries, paying suppliers, replenishing stocks, and paying for any maintenance. All the money you set aside to pay for these things comes under the heading of working capital. So, you can consider working capital to be a kind of company wallet, so to speak. All other costs, such as investments in business items like inventory, cars, or machinery, are not included in working capital.
The importance of working capital
A healthy working capital is significant for a business. When you have too little working capital, you run into problems paying various daily expenses. Therefore, having sufficient working capital is crucial to avoid getting into financially awkward situations. However, as a company, you should also avoid having too much working capital. After all, if you have too much working capital, there is less money left over to invest in the business because, as mentioned earlier, such investments are not part of the working capital. So the excess cash you have in the bank as working capital does not basically earn you anything, and you also incur unnecessary extra costs. Therefore, a good balance sheet is essential in determining working capital. But on what basis is the level of working capital actually determined?
How is the level of working capital determined?
When determining the level of working capital, three factors play a major role: debtors, creditors, and inventories. After all, the longer debtors take to pay the invoices you send, the longer you have to wait for your money. But the size of companies’ inventories also plays a role in determining working capital. As a company, do you have a massive inventory that is only slowly running out? That, too, affects working capital because, as long as the items are in stock, you, as a company, will not receive any money for the respective item. Not just the debtors mentioned above, but also the creditors play a role in determining working capital. The longer it takes suppliers to get paid, the more money a company keeps as working capital.
How do you optimise your working capital?
Keeping your working capital well-balanced is vital. But how exactly do you ensure this as a company? We give you some tips to improve your working capital:
Screening potential customers
Debtors play an essential role in working capital. Do your customers pay late or, at worst, not at all? Then this directly affects the level of your working capital. To avoid this, it is advisable to research the payment behaviour and creditworthiness of potential customers properly.
Focus on multiple suppliers
To avoid getting into trouble with your working capital, it is important not to depend on one or a few customers. Should such a customer, for instance, get into financial trouble or perhaps go bankrupt, this will indirectly also have unpleasant consequences for your working capital. By working with a larger number of customers, you are less vulnerable when a customer drops out.
Make sure you have the right stock
As mentioned earlier, company stock also plays a part in determining working capital. Therefore, always make sure that the stock is correctly aligned with the needs of the current market. By properly researching this and adjusting stock accordingly, you avoid being stuck with large stocks of unsold items.
Optimise the invoicing process
Do you usually spend a long time waiting for the money from the invoices sent? Then it would be good to have a look at your invoicing process. For instance, are the invoices clear enough? Does communication with the customer run smoothly? Is the invoice sent quickly enough? These are all factors that can affect the customer’s payment term. Is the invoicing process fully optimised? Then the problem is probably not on your side but on the customer’s side. At such a point, is there nothing more you can do at all on your side to receive the payment from the invoices in question? Yep, with factoring, for example.
Introducing New Strategies for Working Capital Optimization
Implementing technological solutions
Adopt modern financial software to automate and streamline accounts receivable and payable processes. This technology can offer real-time insights into your working capital status, enabling quicker decision-making.
Leveraging supply chain financing
Engage in supply chain financing solutions, where a third party finances your payables. This approach can extend payment terms with suppliers while ensuring they are paid on time, improving your cash flow.
Dynamic discounting
Offer discounts to customers for early payments. This strategy accelerates cash inflow and reduces debtor days.
Regular financial health checks
Conduct frequent analyses of your financial statements. Regular reviews help in identifying trends, potential issues, and opportunities for improving your working capital.
Optimise working capital with factoring
Have you optimised your invoicing process as much as possible, but are you still dealing with debtors who pay late, too late, or not at all? This can then have unpleasant consequences for your working capital, as you are also dependent on customer payments for a stable working capital. In such a case, factoring is the solution to keep your working capital at a reasonable level. But what is factoring, and how does factoring actually work?
Factoring is a financing method that is becoming increasingly popular among many entrepreneurs. This way of financing revolves around selling invoices to a factor, after which the factor advances you the amount in question. When you sell your invoices to Factris, you will receive the amount in your account within as little as 24 hours. By using factoring, you are no longer dependent on the legal payment term, and you know for sure that you have sufficient funds to put into working capital at all times. The great thing is that once you’ve sold the invoice to Factris, we take care of collecting the outstanding invoices. As a result, you don’t have to worry about the financial settlement with the customer.
