Importance of working capital management SMEs

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The importance of effective working capital management to SMEs

The importance of effective working capital management to SMEs

  • 1 January 2022
  • By OCBC Business Banking
  • 5 mins read

Working capital is cash that is readily available for the day-to-day running of your business.

This includes cash that is used to settle regular bills such as wages and supplies, as well as cover unplanned costs and unexpected expenses. In simple terms, working capital represents the liquidity available to a business.

But what is working capital management? It is not just about financing; it is also about managing business cash flow efficiently and effectively. Small businesses in particular must strike a balance between their assets and liabilities to maintain smooth operations. This is because small businesses lack the capital to absorb large losses in comparison to larger businesses. Proper working capital management is essential to avoid bankruptcy as it gives a business the cash balance its needs to fulfil its obligations.

Working capital management is without a doubt one of the most vital parts of the business and, in most cases, there is a positive correlation between working capital and profit. If we see a shortage in working capital, we tend to see it in the profits too and vice versa. The outlook for running a business has taken a toll whereby the industry has seen an increase in business operational costs such as manpower, utility fees, rental, moving costs and most of all, the increase in cost of goods.

In addition, businesses can expect to experience a longer time to collect business debts due to the slowing of the economy. This would impact on the business cash flow as the cash inflow would be slower to meet the timing of cash outflows, especially in the case of scheduled payments. To meet these difficulties, business owners can consider restructuring credit terms with their creditors or debtors alike to ease the business cash flow pressure. However, given the assumption that other businesses are also working on similar restructuring plans, this will then negatively affect the entire business supply chain, restricting overall purchasing capacity. Lower purchasing power would lead to lower business output and eventually lower profits for all. Thus, it is advisable to make use of facilities offered by banks to bridge the temporary shortfall.

One has to prepare ahead for harder times and make preparations for business contingency plans especially in the face of an impending gloomy outlook. Make ready and set up working capital facilities while your business is running smoothly; don’t wait until your business cash flow is in trouble. The sad truth is that like all businesses, even banks are unlikely to entertain applications from clients when their business is at a risk of failing. Failure due to inadequate cashflow has disastrous effects and contributes to such adverse scenarios that can affect an entire economy. Sourcing an immediate cash reserve for emergency business support only ends up selling the business into higher debts, bringing it closer insolvency.

Most of the small businesses that fail, fail mainly due to poor financial management especially in working capital management. Successful working capital management allows a business to pay off all debts as they mature, or come due, while continuing business operations. At the very least, successful working capital management allows a business to break even. Therefore, working capital management is directly responsible for the avoidance of bankruptcy. In simple terms, working capital is like the nervous system of a business. The following are some key practices to note when building an effective working capital management plan for your small business.

  • Strengthen your business solvency: Working capital allows a business to run smoothly, without financial hitches in making payment for short-term liabilities. Purchase of raw materials and payment of salary, wages and overheads can be made without delays. Adequate working capital helps to maintain solvency of the business by providing an uninterrupted flow in production.
  • Enhance Goodwill: Sufficient working capital enables a business to make prompt payments and hence helps to create and maintain goodwill with lendors and suppliers. Goodwill is enhanced because all current liabilities and operating expenses are paid on time.
  • Obtaining Financing from bank: A business with adequate working capital, high solvency and good credit rating is often viewed favourably by banks when it comes to loan applications. On the other hand, poor working capital management can compromise your eligibility for business loans and damage your ability to attract potential new investors.
  • Regular Supply of Raw Material: Quick payment for credit purchases of raw materials will help your business to maintain a regular supply of raw materials from suppliers and hence continuous production.
  • Smooth Business Operation: Working capital is really the nervous system of a business organisation that needs to stay “healthy”. Any day-to-day financial requirement can be met without a shortage of funds. All expenses and current liabilities are paid on time.
  • Ability To Face Crises: Adequate working capital enables a firm to face business crises in emergency situations such as a financial depression.

In conclusion, to protect against financial difficulties and guard against bankruptcy, it is vital that a business has sufficient cash flow to pay its employees, service its debts, pay its liabilities without delay and react promptly and decisively to competition and changes in the market. An effective working capital management strategy should anticipate all of the above and help to consolidate a company’s gains thus far, while at the same time paving the way for future successes.

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The information provided herein is intended for general circulation and/or discussion purposes only. Before making any decision, please seek independent advice from professional advisors. No representation or warranty whatsoever in respect of any information provided herein is given by OCBC Bank and it should not be relied upon as such. OCBC Bank does not undertake any obligation to update the information or to correct any inaccuracy that may become apparent at a later time. All information presented is subject to change without notice. OCBC Bank shall not be responsible or liable for any loss or damage whatsoever arising directly or indirectly howsoever in connection with or as a result of any person acting on any information provided herein. Any reference to any specific company, financial product or asset class in whatever way is used for illustrative purposes only and does not constitute a recommendation on the same.


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