How to Understand Working Capital Management

“Cash is king”--so say the money managers who share the responsibility of running this country's businesses. And with banks demanding more from their prospective borrowers, greater emphasis has been placed on those accountable for so-called working capital management. Working capital management refers to the management of current or short-term assets and short-term liabilities. In essence, the purpose of that function is to make certain that the company has enough assets to operate its business. Here are things you should know about working capital management.

Instructions

1. Understand that the most important feature of working capital management is the ability to plan a company's cash flow. A company must account for market cycles, minimize the effect of unforeseen events, provide for the loss of a large customer and anticipate the actions of competition.

2. View the company as a whole, not the condition of each unit. By doing this, one division or location that generates excess cash can help another that is suffering temporary shortages. To make this possible, it is important to maintain a close relationship between production and sales and to provide easy movement of cash from one area to another.

3. Be aware of the potential effect of external events on working capital, such as slow repayment of accounts receivable, cash-draining lawsuits and unexpected competitive events. Having contingency plans in place to deal with those events is very important, and they must be based on a realistic assessment of their effect on the company's working capital.

4. Take a long-term view of the company rather than its quarterly earnings and sales. The biggest problem occurs when a company does most of its business seasonally. The pressure on working capital will undoubtedly be greater in one period of the year versus another. In those instances, it's best to plan the company's cash flow requirements for a full 12 months.

5. Know that working capital management is an important function in any company, and it should be an integral part of the company's strategic planning. Improved working capital will increase efficiency and have a positive effect on customer satisfaction.

6. Work with your major customers rather than be completely internally driven; this will pay dividends. For example, helping them assess inventory requirements and matching them up with your own production will help both your company and your customer.

7. Have a dispute management system in place. This will have a potentially positive effect on your working capital, because it will make cash available that otherwise would be in escrow. This feature will improve customer satisfaction because you will be able to focus more on sales and service.