7 ways you can monitor working capital in your business

One of the ways to manage the financial affairs of your business is to monitor working capital. This will enable you to cover for liquidity issues way before they happen.

Running a business requires that you be competent across board. You not only need your unique entrepreneurial mindset but you must also be a good manager and have technical knowledge on the operations of your business.

One of the areas of technical knowledge is financial management. More so, working capital management. Did you know that your day-to-day finances have the biggest effect on your profits? That is why you can’t afford mistakes when it comes to working capital. One of which, is failure to monitor working capital.

Here are 7 ways you can keep your business liquidity in check:

1. Net Working Capital

Let’s face it, as an entrepreneur, you want to keep things simple because the more complex they are the more you have to pay in money and time. That is why there is this simple measure to give you an overview of the state of working capital. From the information in your balance sheet, subtract current liabilities from current asset to know whether you’re in the positive or in the negative.

2. Current Ratio

Have we talked about this before? You’re keen, I like you. We covered the basic ratios to analyze profit, efficiency, debt and liquidity. The current ratio is preferred to point 1 because it tells you by how much your current assets cover your current liabilities (divide assets by liabiliies). It’s useful for when you apply for a bank loan that they know, worst case scenario, even if all your creditors came for their money you’ll pay. It is best-practice that your current assets cover current liabilities twice over.

3. Quick Ratio

Sometimes your current ratio reads fine but banks still refuse to approve your loan. Why? You may be holding too much stock. Stock is not really that liquid because it’s not cash and cannot be exchanged for cash that easily. That is why you need to analyze whether you can pay your creditors even if you sold nothing at all. Yes, current assets minus your inventory divided by current liability. Banks and Saccos want to know if you can weather the worst of times.

4. Accounts Receivable Turnover

You are aware that small businesses do not have room to survive bad debts. This is why you should closely monitor how you collect money owed to you. Obviously, you prefer your credit control measures to enable you collect debt quickly yet not be too stingy to customers that they go for others who offer better terms. From your accounting records, divide your credit sales by your average receivables. You’ll find the number of times you collect debt. You can divide number of days in a year by this figure to know how long it takes you to collect debt.

5. Accounts Payable Turnover

You also want to keep track of your debt payments. Short-term debt depends on the type of business you run. For instance, manufacturers and services businesses like to keep it low. But retail businesses have no option but to have high amounts of short term debt. they can avoid sinking like Nakumatt by monitoring it closely. Take cost of goods sold, from your income statement, and divide by your average accounts payable to find out number of times you repay debt. Divide number of days in a year by this figure if you want to know how long it takes you to repay debt.

Note to you. You should take advantage of your repayment periods since it’s better to have money anyways. But also you want to have high repayment since you can always use this info to negotiate good terms with your suppliers.

6. Inventory Turnover

Look, when all is said and done, the fact remains that the amount of working capital you have is closely related to how much sales you make. You therefore want to sell as much and as fast as possible – or do you? This is where the inventory turnover comes in. You need to know how fast stock turns to cash and, on average, how many days all this sweaty work takes you. Divide the cost of goods sold by average inventory and, like before, divide 365 days by the figure you get to find out days it takes to sell.

7. Working Capital Cycle

The ultimate move if you want to monitor working capital is to keep the cash cycle as short as possible. This is the cycle of getting stock to customer handing over money to your business. Isn’t that what it’s all about? If you have prepared all your financial statements and utilized all of the above measures, this will be easy for you. You add days it takes to clear inventory to days it takes to receive money owed to you. Subtract the average number of days it takes you to pay back debt and you’ll know how many days your cash cycle takes.