BENEFITS OF LOW WORKING CAPITAL
Working capital is a company’s current assets serving as a liquidity cushion, as indicated on its balance sheet. In simplest terms, working capital = simply total current assets – total current liabilities. Current assets cover the current liabilities in the same cycle and should be converted back into cash within 12 months. But not all assets are liquid in case cash is needed to settle short-term obligations, affecting a corporation’s financial stability.
Having said that, it is better for a company to maintain a minimal amount of working capital to pay bills and debts on time.
A low working capital improves the productiveness of operations. Different companies have varying working capital requirement. When a firm retains a low working capital, that corporation is forced to bolster their operations. That way operating cash flows plus extra working capital can shoulder operational expenses.
Similar to leverage in forex, working capital can act as a double-edged sword which ensures either liquidity or impedes capital that could have been allocated elsewhere. To maximize the use of long-term funds, it is important to have a minimal working capital. Keeping the capital to a minimum escalates the efficiency of investments, making these investments more attractive.
Another benefit of low working capital is shortened cash conversion cycle. However, the purpose of low capital is defeated if the collection process takes long. Not to mention inventories tend to lock up funds for long time periods. Aside from that, finished goods may not be sold for some time, extending the cycle. For funds to remain within the cycle for the shortest time possible, all products must be sold right after production.
How can companies achieve low working capital?
Entities can adopt on-demand or just-in-time operations by keeping little or no inventories in unused materials and unsold products, resulting in disbursing minimal or no working capital. One way of doing so is coordinating with suppliers. Under this setup, a corporation won’t purchase any material until it is needed for manufacturing products or orders are obtained.
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