Working Capital | Know Importance, Benefits & Eligibility - MYND Fintech



Ask any businessman, and he will tell you the importance of working capital. It is like oxygen for a business and helps a business maintain its solvency.

WHAT IS WORKING CAPITAL?


Also known as Net Working Capital (NWC), Working Capital (WC) is defined as the difference between a company’s current assets and its current liabilities. It is an indicator of a business’s liquidity and short-term financial health and its ability to utilise its assets efficiently.

IMPORTANCE OF WORKING CAPITAL MANAGEMENT:


When a company’s current assets are more than its current liabilities, it is said to have positive working capital. This means that the company is in a good position in terms of liquidity and financial health. Hence, having a positive WC helps a company maintain its solvency. The various factors which highlight the importance of working capital are as follows:

  • Managing liquidity: By getting a clear idea of impending expenses or expenses coming up, the finance department can take stock of their financial position and arrange for the funds accordingly.
  • Avoiding out-of-cash position: Inappropriate planning to day to day expenses may cause liquidity issues. In such a case, the company may have to postpone or arrange funds from other sources, which negatively reflects the company’s image.
  • Helps decision-making: By correctly calculating the requirement of day-to-day funds, a company takes stock of its current fund position. This allows the company to decide the amount and source of funds.
  • Adds value to the business: As the management arranges for funds to manage its day to day expenses, the finance department can meet all its payment obligations. This sends out a positive message in the market about the company and enhances its value.
  • Earn short-term profits: There are situations when a company has excess funds with them. By calculating their working capital requirements, the company can estimate the amount of excess funds. Over and above the working capital requirements, the company may invest extra funds for the short term and earn some profit.

THE BENEFITS OF WORKING CAPITAL FOR ANY BUSINESS:


Working capital is like oxygen for a business. Just like we need to breathe oxygen, businesses need to have it. Without sufficient amounts, a company cannot meet daily expenses, pay salaries, make supplier payments, and pay raw materials.

ELIGIBILITY CRITERIA — WORKING CAPITAL LOANS


To be eligible for getting working capital loans, the following are the eligibility criteria:
  1. The applicant must be between 24 to 70 years of age. The applicant must not be over 70 years at the time of maturity of the loan.
  2. The business must have an operational history of more than 3 years.
  3. In the case of last year annual turnover being more than 1 crore, the financial statements must be audited by a CA.
  4. A good credit rating makes it easy to get a loan and helps get a good deal.

DISADVANTAGES OF DEPENDENCE ON WORKING CAPITAL:


While working capital is an essential tool to maintain the liquidity of a business, there are some disadvantages in depending too much on it.
  • Takes into account only monetary factors: Working Capital works purely on numbers. It just takes into account monetary factors like the value of debts receivables, the value of finished goods, the value of accounts payables, etc. Factors like recession, employees’ dissatisfaction, government attitude toward the industry etc., hold no relevance here. All this make working capital management purely a number game, which may not be accurate always.
  • Does not respond to sudden market changes: Working Capital Management is not dynamic in nature. It is mainly based on past data and events and does not acknowledge sudden changes in the market conditions. In today’s dynamic business situations, a delay in responding to a specific event may hurt business operations and profitability.
  • Based on data solely: At the centre of Working Capital Management lies the data. It’s the soul of this cycle. Data includes every minute detail of the working capital cycle. For example, in accounts receivables, it would require the date of sale, the credit period, grace period, penalty in case of delay or non-payment etc. Without data, this strategy does not work. Any error or change in this data may disrupt the entire cycle.
  • The problem in interpretation: Working capital management works purely on numbers, ratios to be precise. And interpretations of these ratios are very subjective in nature. For example, experts believe that in the case of current assets, a 1:1 ratio is favourable. At the same time, ratios higher than 2:1 are unfavourable. In case, a business has a longer trade receivables cycle than the industry’s average, it would not be able to interpret the ratio accurately.

SUPPLY CHAIN FINANCING — THE MODERN WAY OUT


Supply Chain Finance, also called Supplier Finance or “Reverse Factoring”, is an easy and simple way to get funds to meet the working capital requirements of a business. It helps a company get quicker payments for their invoices. This method usually involves a third party or lender (usually a bank or financial institution) who finances the business on behalf of the end customer.
Simply speaking, in supply chain finance, suppliers sell their high-ticket invoices to lenders (banks, financial institutions, or NBFCs) at a discounted rate to get short term credit. This receipt of this money, much before the invoice due date, gives breathing space to the business and helps them fulfill their operating commitments.

BENEFITS OF SUPPLY CHAIN FINANCING OVER WORKING CAPITAL


Every business wants to get paid as soon as possible. This may not be a problem with cash-rich companies, but for most MSMEs, getting a regular fund flow prevents them from getting chocked. Given below are some benefits of supply chain financing:

  • Manage inventory more efficiently: While focusing only on Working Capital, a business may have to have more inventory as current assets to maintain a positive WC. This may increase their inventory carrying costs.But with supply chain financing, since the business is able to get payments faster, they can afford to have a shorter cycle. So, they can place smaller but more frequent orders as and when required. This helps them manage their inventory and its carrying costs in a better manner.

  • Reduce Days Sales Outstanding (DSO) from customers: Working Capital takes into account the credit period, but it does not take into account the time value of money and the cost of opportunities missed if the money is blocked in accounts receivables. Supply chain financing helps a business reduce its DSO and allows a business to rotate that money into the next production cycle or invest in some more profitable venture.

  • Increase Days Payables Outstanding (DPO) from suppliers: Working Capital takes into account the difference between the current assets and current liabilities. Supply Chain financing helps businesses push their accounts payables to a later date, thereby giving them more breathing space. Using this, businesses can pay their suppliers later and enjoy a greater credit period than what the supplier offered.

  • Strengthens buyers-supplier relationships: Supply Chain financing helps both the suppliers and the buyers. While the suppliers get quicker payments, the burden is not passed on to the buyer. Similarly, the buyers get an extended credit period without the supplier having to suffer. This way, both parties can achieve their business objectives efficiently. Both parties are invested in the success of each other. This makes their business relationship more and more strong.

CONCLUSION


Working capital is significant to keep a business solvent. A positive WC indicates the short-term financial health of a business. A business with a positive WC ratio can meet all its current liabilities and is believed to be financially sound. But at the end of the day, it’s just a ratio analysis.

Supply Chain Financing is a more practical and dynamic approach compared to working capital management. It lets you run your business without any interruptions and also allows you to take advantage of business opportunities that come your way. It is a highly flexible and reliable method of financing for businesses that require continued working capital. So, if you are getting stuck somewhere and need funds for a shorter time, then supply chain financing makes much financial sense. To know more about how supply chain financing can help overcome various business challenges, give us a call. We will be glad to help you.

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