What is the Importance of Working Capital?
Working capital is very important because it helps business manage their day to day operations and make key investment decisions in such a way that they are never out of cash and don’t face liquidity issues.
Here are the top 8 reasons why working capital is important –
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Source: Importance of Working Capital (wallstreetmojo.com)
#1 – Liquidity Management
By properly analyzing the income, expenses and payablesPayablesAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more, the financial and accounting team of an enterprise can easily plan for their funds accordingly.
#2 – Out of Cash
Inappropriate management of day to day expenses may result in enterprise liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more issues. Therefore, the planned management of working capital can avoid such a situation.
#3 – Helps in Decision Making
By correctly analyzing the requirement of funds for day to day operations, the finance team can appropriately manage the funds and can decide on available funds and the needed funds.
#4 – Addition in the Value of Business
Proper working capital management results in timely payment to the lenders, which creates goodwill in the market.
#5 – Helps in the Situation of Cash Crunches
By properly managing the liquid funds, one can help the organization avert any cash crunch and pay for its day to day expenses on a timely basis.
#6 – Perfect Investments Plans
Correctly managing the funds or working capital, the company can plan for their investments accordingly and maximize its return.
#7 – Helps in Earning Short Term Profits
Some enterprises keep a large buffer of funds as working capital, which is way over and above the required level of working capital. By correctly estimating the required working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more, the extra funds can be invested in other projects that may result in higher profits.
#8 – Strengthening the Work Culture of the Entity
Timely payment of all day to day expenses like the salary of the employees creates a good environment and motivates employees to work harder.
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