Back to: Financial Management
Good day, class! Welcome to Week 8. So far, we’ve discussed big financial decisions like investments and how much it costs to raise money. But what about the day-to-day running of a business? After all, businesses need money not just for long-term projects, but also to pay workers, buy materials, and keep operations going smoothly. That’s where Working Capital Management comes in.
So, what is working capital?
Working Capital Management
Working capital is the money a business uses for its daily activities. It is calculated as: Working Capital = Current Assets – Current Liabilities
Let’s break that down: – Current assets are things the business owns and can easily turn into cash within a year. These include cash, inventory (stock), and accounts receivable (money customers owe the business). – Current liabilities are what the business owes and must pay within a year—such as loans, bills, and payments to suppliers.
If a business has more current assets than current liabilities, it has positive working capital, which is a good sign. It means the business can meet its short-term obligations and keep running smoothly.
But if liabilities are more than assets, the business may struggle to pay its debts or even stay open.
Working capital management is the process of ensuring that a business has just the right amount of current assets and liabilities to operate efficiently. The aim is to avoid two dangers:
Having too little working capital, which can lead to cash shortages.
Having too much money tied up in assets, like unsold stock or unused cash, which could be used more productively elsewhere.
Let’s look at the main components of working capital and how they’re managed:
1. Cash Management
Cash is the most liquid asset. It is needed for paying salaries, buying materials, and settling bills. But holding too much cash means the money isn’t being invested or used to earn profits. Businesses must balance how much cash to hold for emergencies without wasting the opportunity to earn more with it.
2. Inventory Management
This involves managing stock. A business needs enough stock to meet customer demand, but not so much that it becomes wasted or expensive to store. Poor inventory management can lead to lost sales or unnecessary costs.
3. Receivables Management
When a business sells on credit, customers don’t pay immediately. Managing receivables means making sure customers pay on time. If they delay, the business may run out of cash. Sometimes, businesses offer discounts for early payments to improve cash flow.
4. Payables Management
Businesses also buy goods and services on credit. They must manage how and when they pay suppliers. Paying too early can affect cash flow, while paying too late can damage relationships and credit ratings.
A skilled financial manager finds the right balance between all these parts. The goal is to keep the business running smoothly every day without taking on too much risk or missing out on better opportunities.
In Nigeria, many small and medium-sized businesses face challenges with working capital. They often struggle to collect payments from customers and may not have access to quick loans. This is why working capital management is not just a theory—it is a survival skill in the real world.
In summary, working capital management is about making sure a business has enough cash and short-term assets to operate efficiently without being wasteful. It’s about balance, timing, and careful planning.
Next week, we’ll look at financial planning and forecasting—how businesses prepare for the future based on current information. Until then, observe how small businesses around you handle stock, payments, and day-to-day cash. You’ll start seeing working capital in action.