How do I Choose the Best Working Capital Strategies?

Working capital strategies are the plans relating to future cash flows for business activities. Business owners and managers typically plan these strategies for both short-term needs and long-term goals or objectives. These plans may also make extensive use of budgets, which help companies control expenditures and limit or prohibit future negative cash flow situations. Selecting the best working capital strategies depends on the type of business, working capital cycle, management ability, and external economic factors.

Business owners and managers typically use a basic formula to calculate working capital. This formula is current assets minus current liabilities. Both current assets and current liabilities are typically used in 12 months or less, making them essential to measuring working capital. Current assets and current liabilities include cash and cash equivalents, accounts receivable, inventory, short-term securities and accounts payable and short-term loans, respectively.

Businesses typically require different types of working capital strategies. For example, retail stores need strong working capital because they must have enough cash to consistently restock inventory products. Automobile dealerships typically do not have copious amounts of working capital because they use floor plans to generate long-term financing for their vehicle inventory. Companies that need constant cash flow will attempt to limit current liabilities, which often require paying cash for current assets rather than trade credit or short-term lines.

The working capital cycle helps business owners and managers determine how well their companies generate cash flows, which is a critical part of working capital strategies because cash is the most fungible good of current assets. Inventory, accounts receivable, and accounts payable directly affect working capital. Companies that collect or have lower accounts receivable, obtain longer periods to pay vendors for goods and services or sell inventory quicker can improve their cash flow and working capital. The opposite will occur if companies are unable to secure benefits from the items, resulting in lower working capital.

Economic factors — commonly outside of the company’s control — can also affect working capital strategies. Tight monetary policies, unavailable business credit or low consumer income can focus companies to implement strategies that retain working capital, rather than investing this asset into the business. Under these sour economic conditions, business owners and managers will seek to lower accounts payable and avoid increasing balances on the company’s credit line. Avoiding excessive inventory purchases or account sales can also help companies retain cash and improve their working capital position. Cash flow can be more important than generating income during economic downturns.