In the establishment of any business, a factor that plays a key role is capital. Once it is established, cash flow is another key part that determines the rate of the progress of your business manage. According to a survey, 29% of businesses have failed to survive in the market due to insufficient cash flow. However, along with cash flow, working capital is also just essential. Having a sufficient amount of working capital is also a major requirement for any business manage.
In simple words, the difference between cash flow and working capital can be described as:
Cash flow is the sum of money that a business is earning over a certain period. Whereas in comparison, working capital is the sum of money is that the business has at that particular time.
What is meant by the word working capital?
Working capital can simply be defined as the difference between the current liabilities and current assets of a company. In this definition, the word current refers to a time of 12 months.
If the amount of current assets is larger than the number of current liabilities then the company is said to have positive working capital. However, if the amount of current assets is smaller than the number of liabilities then the company is said to have negative working capital.
Working capital is different from investment capital that is used to fund large projects that are meant to stay for a longer period.
In contrast, working capital can be used for smaller requirements that could be as simple as buying raw materials. This is not only applicable for product-based companies but also to services. Working capital can still be used to buy payrolls and to fulfill other expenditures.
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Effect of operating cycle on working capital
There is a very close relationship between the working capital and the operating cycle. The operating cycle refers to the time the cash is spent to purchase raw materials and manufacture the products and the time that cash is received back by the company. This movement of cash can be described as a cash-to-cash cycle.
The operating cycle is the leaving and returning of the cash into the company’s account. However, during this cycle, one thing that plays a key part is the working capital.
There is no fixed duration for the operating cycle. It can last a few days or sometimes months as well. But the necessary point is to keep it going without any interruption and for that working capital is required.
It’s hard to organize the working capital appropriately. This is because it’s tough to be funded at every operating cycle. This means that there is more than one operating cycle depending upon the production requirement of each company.
Ways to enhance your operating cycle
The operating cycle is a basic necessity for any business manage. To fulfill this need, there should be proper measures taken so that the working capital is enough to manage the operating cycle.
An effective way of financing the working capital is through equity. That means the respective owners of the business puts up more capital. To finance their business, they might as well take the option of small business loans. SBA loan is a good option and for getting a better viewpoint regarding this owners can even take suggestions from the SBA loan consultant. When the businesses have sufficient working capital loans then, they can carry out their day-to-day operations at a faster pace.
Another effective way is to be on better terms with your supplier. If you reduce the payment term then the operating cycle would also be lessened from the front end. You can also reduce the customer payment terms.
For creating a better vision of the operating cycle, the very first thing that you must be concerned about is its time duration and how long it lasts. Once you are clear with that you will be easily able to calculate the working capital that would be available by the end of the operating cycles.
Seasonality and its effect on working capital
Businesses that are highly variable in terms of their sales throughout the year are required to manage their working capital much more efficiently. For the time of year when the sales are the lowest, the company is facing a serious decline in terms of its capital. So at that time, they must put their entire focus on the production for the season when the sales are the highest. This is one good way of managing the working capital.
To conclude, one major factor that greatly affects the working capital is the operating cycle. So to improve your working capital, make sure to manage your operating cycle first.
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