If you own a business, you are constantly looking at the numbers to determine where you stand financially. Understanding working capital management is important if you plan on operating your business successfully. Analyzing the different ratios associated with your day to day operations is the key to giving you the answers you need to make better financial decisions. Using the information you receive by working these ratios will allow you to improve your potential for growth and gives your business an opportunity to keep moving forward.
What Is Working Capital Management?
Working capital management involves using three distinct sets of numbers to evaluate your company’s financial health. The CCC, or cash conversion cycle, is used when working with working capital management. Understanding how your net assets and liabilities are converted into usable cash that will support your business’s day-to-day operations. Using the concepts associated with working capital management, you will be able to manage every aspect of your business on a financial level. You will be able to pay your debts and minimize the amount you spent to operate your business.
Understanding the Three Ratios
There are three primary ratios used in working capital management. When the three ratios are used together, they provide an accurate depiction of your company’s financial health.
- Working Capital Ratio – Assets divided by liabilities will show whether or not you are able to accommodate your immediate financial responsibilities.
- Collection Ratio – This amount is figured by taking the number of days in a specific period by the number of accounts receivable, That number is then divided by the amount of net sales (credit) for the same period.
- Inventory Turnover Ratio – This ratio is calculated by dividing revenues by the cost of the company’s inventory. The result gives you a good idea as to how efficiently your inventory is being sold and replaced.
When these numbers are collected and analyzed on a regular basis, you will have an accurate view of your company’s financial well-being. Because these numbers fluctuate regularly, these ratios will need to be factored on a regular basis, either monthly or quarterly, to be effective.
Using the Information to Its Fullest Advantage
Working capital management gives you the information you need to take control of your company’s cash flow. The three ratios will show you various factors that affect how efficiently your company handles its money. You will begin to understand the strengths and weaknesses within your financial budget and structure. Using the information you gain from these ratios is a good way to get your business back on track financially.
When you have concerns about your company’s financial status and want to get a better idea of how well cash flow is moving, then you want to embrace the concepts of working capital management. Working capital management is one of many different tools you can use to keep tabs on both your budget as well as your financial statements. Taking advantage of every tool in your financial toolbox is the best way to maintain control of your company’s finances and effectively fine-tune your budget for maximum efficiency.
