Finance Policies for Working Capital
Managing business working capital requires an understanding of its components and the finance options necessary to achieve the desired liquidity levels for short-term success. Liquidity refers to cash and assets that are easily turned into cash. These liquid assets must be sufficient to enable a business to operate effectively. If cash and liquidity are insufficient to cover short-term uses of funds, a business must have a set of working capital finance alternatives in place.
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Managing Working Capital
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Working capital is composed of short-term assets; cash, inventories and accounts receivable less short-term liabilities; primarily accounts payable. Cash can be managed by putting excess cash that is not needed within the next few weeks into money market accounts that can be drawn upon as needed. Money market accounts provide an interest income that contributes to additional cash. Inventory management requires an awareness of the minimum levels needed to support sales. It includes sales forecasting and the related inventory to support sales. Excess inventory will create unnecessary uses of funds that reduce cash and contribute to less liquidity of your working capital.
Accounts Receivables
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Accounts receivable management is important to the liquidity of working capital, especially when a large number of sales are on credit. If there are a significant number of slow-paying accounts, working capital is impacted in a negative way. A good finance policy for working capital is either factoring for the slow-paying accounts or getting short-term accounts receivable loans. Factoring agreements set up with a financial business will enable the receipt of cash, less a fee, when a sales invoice is issued. This increases the liquidity of the business.
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Accounts Payable
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An important short-term use of working capital involves accounts payable to suppliers. The best way to manage these accounts for working capital liquidity is to maintain an accounts payable aging report. A supplier that you purchase from frequently may be willing to provide a longer payment period than other suppliers. This will have a positive effect on liquidity and require less short-term credit financing actions.
Other Short-Term Finance Options
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Improving the liquidity of working capital can involve the use of business credit cards. This finance policy requires careful control of the credit, so that it is used sparingly for short-run liquidity needs. Interest rates on this form of credit are higher, which can have a negative impact on liquidity.
If a key supplier accounts payable has become large, and payments are falling behind, a finance policy alternative could involve turning the debt into owner equity. This could be appealing to a supplier, even though the debt goes away, since they now have an ownership interest in your business. By reducing accounts payable, working capital is improved.
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