As individuals, our budgeting process is simple. We cover essential expenses like rent and utilities, save a chunk of our income, and keep the rest as ‘spending money’ for the rest of the month.
In the same way, businesses set aside a certain amount of funds. These funds act as the working capital to address the day-to-day operational expenses of the business. Working capital is the lifeblood of a business. Businesses use working capital funds to manage inventory, pay suppliers and meet short-term obligations.
Effectively managing working capital ensures a worry-free approach to payments. However, achieving this balance can be challenging, akin to walking on a tightrope.
Business owners make common blunders that can jeopardise the success of their companies.
Mistakes to avoid during working capital management
1. Neglecting the working capital management process
As a business owner, overlooking working capital management is among the most significant mistakes you can make. While revenue management and operations are crucial, working capital management should never be ignored. As this is an integral component of your business, ignoring it can compound the problem.
Adopt a proactive approach to managing working capital by regularly monitoring cash flow and optimising the timing of payables and receivables.
2. Ignoring the importance of net working capital
Working capital is a critical metric that reflects the liquidity of your business and short-term financial well-being. Just like you can use an individual's loan burden to judge how good they are at finance management, you can use the net working capital to evaluate the financial management of your business.
You can calculate this by subtracting the current liabilities from the current assets. Ignoring net working capital can lead to imbalances in cash flow. This, in turn, can result in difficulties in ensuring your vendors and suppliers are paid on time.
3. Failing to forecast cash flow
This may sound like an impossible task, but, it is an essential step in the budgeting process for a business. It is necessary to have an estimation of your annual cash flow. After all, if you have no idea how much money will come in, how can you spend that money?
Failing to accurately forecast cash flow can lead to unexpected shortages or surpluses. You should develop comprehensive cash flow forecasting models, considering all the variables relevant to your business.
Also Read: Cash Credit vs. Overdraft: Which is best for your business?
4. Overlooking permanent working capital needs
Permanent working capital is the minimum current assets required to sustain ongoing operations. Sometimes, business owners overlook the importance of maintaining enough permanent working capital. Temporary working capital can take time to procure, thus putting your daily operations to a standstill.
Don't make this mistake. This can result in liquidity issues and affect the stability of your business.
5. Allowing negative working capital
Negative working capital occurs when current liabilities exceed current assets. As you can imagine, this indicates potential financial distress for the company.
While negative working capital might seem beneficial in the short term as it indicates the ability to fund operations using supplier credit, it is not sustainable in the long run. Making a habit of this can strain relationships with your suppliers and adversely impact your business reputation. You must try to maintain positive working capital at all times.
6. Mismanaging inventory
Inventory management is a deceptively complex area of business operations. It can have quite an impact on your working capital.
For instance, you can have all your calculations done perfectly. Then, an unexpected inventory restocking order can blow your budgeting straight out of the water.
Inventory management techniques like just-in-time inventory and regular demand forecasting can help strike the right balance and optimise working capital.
7. Relying solely on Working Capital Loans
Although Working Capital Loans can offer a temporary cash flow boost, relying solely on borrowing to fulfil your working capital requirements is risky. It can lead to a debt burden, increased interest expenses and potential cash flow constraints in the future.
Having said that, you should consider utilising Working Capital Loans smartly instead of depending on them blindly. Axis Bank Working Capital Loans come with a range of benefits like cash credit and GST-based overdraft. You can use this as a short-term measure and repay it once your cash flow stabilises.
Conclusion
Effective management of working capital is vital for the financial health and sustainability of a business. By avoiding common blunders, you can ensure a positive net working capital and maintain a healthy cash flow. Remember to practice prudence and precautions to ensure that your working capital management is optimised.
Also Read: Six common investment mistakes to avoid at all times
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
