Working Capital Management (WCM) manages liquidity and capital supply to maximize return. It is a critical aspect of any business as they need to quickly access funds to make payments on their debt, pay workers, buy raw materials and equipment, and pay suppliers. They are maintaining a balance between a business’s long-term and short-term objectives. Companies must have adequate working capital to operate efficiently and effectively and maintain sufficient reserves to provide for unexpected expenses.
Factors Affecting Working Capital Management
1. Dependency on the major suppliers and contractors
Dependency on the major suppliers and contractors is one-factor affecting working capital management. Suppliers sometimes cannot fulfill their part of the deal mainly because they cannot get their hands on needed materials due to a shortage in supply or because they do not have sufficient stock. In such situations, maintaining an emergency supply helps protect your business from being negatively affected by not fulfilling your obligations to your clients or customers.
2. Cash Management Strategy
Cash Management Strategy affects working capital management in several ways. One of the ways is that it affects the amount of cash you have access to in each business cycle. In general, a working capital management system should enable the fast release of funds from the firm’s bank account to maximize cash flow and minimize the risk of overdrawing your account.
3. Nature of the Business
The nature of the business can affect working capital management. If a company has a high rate of returns from its suppliers, it can do without massive cash in other areas as more money flows into the firm. If this is not the case, you may need to secure long-term financing or finance options to run operations while waiting for the debt to be repaid.
4. The organization’s liquidity position
The organization’s liquidity position affects working capital management because the amount of cash available to act as a buffer against short-term demands is a direct function of the organization’s ability to produce some money. If the firm has more cash, it can use this to ensure it can meet its financial obligations. However, if the firm has no money coming in, it will have difficulty producing cash and may have trouble meeting obligations when they are due.
5. The organization’s credit profile
The organization’s credit profile affects working capital management because it relates to its ability to borrow money. If a firm has a good credit rating, it can borrow money quickly and access more funds from lenders, increasing its available working capital. However, if the firm’s credit is poor, it will not be able to secure loans at all and may have trouble meeting its financial obligations.
6. The firm’s business strategy
The firm’s business strategy affects working capital management because it determines the need for longer-term credit. If, for example, the goal of a business is to settle down in the market, then it would seek long-term financing rather than short-term. It will then ensure that the working capital they have is there to be used on longer-term projects and operations rather than getting access to funds before having extra funds coming in.
7. The direction of the economy
It affects working capital management because it determines the industry activity level in an economy. The amount of cash a firm has to use in different areas of its business will change as the firm’s ability to secure short-term finance will change as the economy changes. Equally, a firm’s cash position will change as its ability to secure funds from lenders changes.
8. The overall financial strategy
The overall financial strategy that a firm adheres to effects working capital management because it determines the amount of funding the firm will need for each project and operation. For example, if a firm does not want to secure long-term financing and plans to rely on short-term funding instead, it will affect its working capital management system. The cash flow proceeds that the firm gets in each cycle may also be different to maintain its short-term financing.
9. The level of debt
It affects working capital management because it determines the amount of funding the firm must pay off in each cycle. For example, if an organization’s short-term financing is low, it will need to use more funds to make payments on its debt, such as interest and premium payments. It will directly affect its working capital management as it will need to clear more money away from cash flow.
Working capital management is one of the essential functions in any organization. Taking a long-term and short-term approach to managing working capital is necessary. A firm should make sure that it has adequate working capital to meet its obligations and that it has sufficient reserves in case of an emergency.