Working capital is essential for an SME (small to medium-sized enterprise). It enables them to manage daily operations, invest in growth opportunities, and navigate financial challenges. Being able to effectively manage working capital ensures that businesses have sufficient cash flow to cover short-term obligations and capitalise on new growth initiatives.
What is Working Capital?
Working capital represents the difference between a company’s current assets and current liabilities. It’s a measure of a company’s liquidity and its ability to meet short-term obligations. The formula to calculate working capital is done simply by deducting the assets from the liabilities.
Having a positive working capital will indicate that the company can cover its short-term liabilities with its short-term assets, while a negative working capital suggests potential liquidity issues.
There are several reasons why working capital is important for SMEs:
- Better management of daily expenses such as payroll, rent, and utility bills without disruption.
- Investment in new projects, purchase inventory, or expand operations, driving growth and competitiveness.
- Provides a buffer against unforeseen expenses or economic downturns, enhancing business resilience.
Did you know industry experts suggest that maintaining an optimal level of working capital can maximise profitability for SMEs.
There are several challenges a business will face when managing working capital, these include:
- A struggle to secure additional external funding – making efficient working capital management crucial.
- Delayed payments from customers causing a strain on cash flow – making it difficult to meet short-term obligations.
- Holding excessive inventory – ties up cash.
- Insufficient inventory – leads to a loss of sales.
There are several strategies which can be deployed to improve working capital management:
- Efficient inventory management – maintaining optimal inventory levels will free up cash without compromising the ability to meet customer demands.
- Streamline receivables – implementing clear credit policies and follow up promptly on overdue invoices to reduce debtor days.
- Negotiate payables – work with suppliers to extend payment terms where possible, helping to improve cash flow without harming supplier relationships.
- Utilise working capital finance – explore financing options such as working capital loans, invoice financing, or asset-based lending to bridge cash flow gaps.
The NGI team have recently helped a healthcare recruitment business who have experienced rapid growth but were facing a cashflow squeeze. They needed help with working capital to assist with meeting tax and payroll obligations along with boosting cash reserves. We facilitated £30K of funding over a 12-month term with ability to top-up or settle early, all done in just 3 days.
For SMEs, effective working capital management is essential for sustaining daily operations, facilitating growth, and enhancing profitability. By understanding the components of working capital and implementing strategies to manage it efficiently, businesses can strengthen their financial health and position themselves for long-term success. Finally, where possible businesses can utilise working capital loans to provide an injection of funding which can be used for various day to day needs.
If you have any questions with regards to working capital, please call us on 01993 706403 or e-mail enquiries@ngifinance.co.uk.