How to Reduce Working Capital in a Business? Explained

Working Capital

Working capital is a financial tool that shows a company’s ability to pay its short-term debts. By measuring the difference between its current assets and liabilities. So, It is important for companies to have positive working capital. And check it to confirm that they have enough liquidity to meet their short-term debts.

Definition

Gerestenburg defines, “Circulating capital means current assets of a company that is change in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables into cash”.

 

Shubin defines, “Working capital as the number of funds necessary to cover the cost of operating the enterprise.”

 

Weston and Brigham define, “Working capital refers to a firm’s investment in short-term assets – cash, short-term securities accounts receivables, and inventories.”

 

Hoagland defines, “Working capital is descriptive of that capital which is not fixed. But the more common use of the working capital is to consider it as the difference between the book value of current assets and the current liabilities.”

 

Mead, Malott, and Field define, “Working capital means current assets.”

 

Bonneville defines it, as “Any acquisition of funds which increases the current assets, and which increases the working capital for they are one and the same.”

 

J.S. Mill defines, “The sum of the current assets is the working capital of the business.”

 

There are several ways to reduce working capital in a business:

Assets perspective

Improve inventory management

We can do this by executing just-in-time inventory systems. So it reduces excess inventory and optimizes stock levels.

Streamline accounts receivable

This can be done by implementing credit policies, setting payment terms, and following up on outstanding accounts.

Optimize accounts payable

This can be finish by negotiating payment terms with suppliers, taking advantage of early payment discounts, and automating invoice processing.

Optimize cash management

I can do this by implementing cash forecasting systems, identifying and reducing unnecessary expenses, and maximizing the use of cash reserves.

Outsource non-core activities

This can be finish by outsourcing activities that are not critical to the business, such as logistics and customer service, to reduce the need for inventory and staff.

Execute barcode scanning and tracking

This can be finish by using barcode scanning and tracking technology So to improve inventory accuracy and reduce stockouts.

Implement automated purchase order systems

This can be Finish by automating buy order systems to reduce the time and resources required to manage accounts payable.

Implement a sales order processing system

This can be Finish by implementing a sales order processing system So to improve the speed and accuracy of order processing and reduce the number of accounts receivable.

Liabilities perspective

Reduce short-term debt

This can be done by paying off short-term loans or credit lines, or by banking them with longer-term debt.

Increase long-term debt

This can be done by issuing bonds, taking out a long-term loan, or retaining earnings.

Increase equity

This can do this by issuing new shares of stock, retaining earnings, or reducing dividends.

Negotiate extended payment terms

This can be done by negotiating longer payment terms with suppliers So to reduce the number of accounts payable.

Power supplier financing

This can do this by working with suppliers to get financing. Such as supplier credit, to reduce the need for short-term debt.

Add a credit management system

We can do this by implementing a credit management system. So to reduce the risk of bad debt and increase the efficiency of accounts receivable.

Implement a bill discounting facility

This can be Finish by working with a financial institution to get a bill discounting facility. So that it allows a business to sell its accounts receivable at a discounted rate to improve cash flow.

Use factoring

This can be Finish by working with a factoring company to sell accounts receivable at a discounted rate to improve cash flow.