Working Capital Problems That You Need to Know

Since the beginning of demonetisation, working capital problems have been prevalent in MSMEs, and your company could be next. The India SME Forum recently conducted a survey to assess the effects of demonetisation on MSMEs two years after its implementation.

According to more than 58 per cent of MSMEs, Demonetization was a primary cause of the decrease that occurred at the time due to the inability to pay in cash. Could that, however, have been the only reason? This is where understanding working capital comes into play. Good working capital management comes in handy when it comes to unexpected financial decisions that could impact the business. When it comes to working capital, it is sometimes necessary to be aware of the issues you are experiencing. Common working capital problems are:


  • You cannot carry out your day-to-day operations if you lack working capital.
  • Your company misses out on market opportunities like cash discounts and bulk lower product prices.
  • Your company's creditworthiness may suffer if you cannot pay off your obligations once they have matured.
  • Due to a lack of working capital, you will miss out on excellent investment and expansion opportunities.
  • Your small business will be unable to use fixed assets, and the value of your assets will depreciate, resulting in increased costs.
Working Capital Problems

Working capital issues can be caused by a variety of factors, including:


1-Inadequate sales performance


Gross sales are one factor that contributes to a positive working capital flow in your company. Sales drive a company's revenue. If sales are strong, you can compute working capital to determine how much your company owes at the end of the year. You are safe if you have enough liquid assets to pay your bills. However, if your sales performance is poor, you know you have a working capital problem. When there is less cash flow coming in, there is less money to make payments later.


2-Receivables that are past due


When your past-due receivables increase, your working capital problem. Accounts receivable are payments that a company has yet to receive from customers who bought goods or services on credit. A small business's credit line is reduced when it extends to its customers. One of the most simple ways to improve days sales outstanding is to tighten credit and collection policies (DSO) and working capital problems.


3-Delivery of poor quality


Customers are underpaying as a result of quality issues. Customers will be dissatisfied if small businesses facing working capital problems with a capital crunch fail to deliver on quality with their products or services. When you work with dissatisfied customers, they will delay payments demand refunds, and you will end up with an unsustainable cash flow over time.


4-Inadequate inventory management


Detailed inventory information is not available, and there are issues with inventory turnover. Companies must purchase inventory regularly to keep their operations running; however, if a company's inventory includes raw materials and finished goods. Inadequate stock levels can lead to lower sales and customer delays, creating a vicious cycle of poor cash flow into the company leading to the working capital problem.


5-Delay in vendor payment


When your customers do not pay you on time, you do not pay your vendors on time. As a result, the vendor faces late payment penalties and financial difficulties. This will affect your cash flow, and the time lag for meeting your working capital requirements will be extended. This could lead to a business breakup, and you'll be looking for a new vendor.


How to Prevent Working Capital Issues:


To avoid working capital problems, your company can shorten its cash flow by reconfiguring its receivable accounts, inventory management, and accounts payable practices to shift their duration and, thus, the amount of working capital. It all comes down to efficient cash management, which is essential:

  • Offering customer incentives, such as early payment discounts, accelerates accounts receivable receipts, for example, in 10 days rather than 30.
  • Increasing your inventory necessitates a significant investment. Freeing up capital by reducing inventory can be an effective way of improving cash flow, though this is also dependent on the external environment of your business.
  • Make the right hire! Hire someone to manage your account receivables by calling customers and securing timely payments.
  • Implement a necessary inventory timetable to avoid worrying about idle inventory that will become obsolete and not generate income.
  • Payment and billing procedure enhancements can do wonders for a company's days payable outstanding (DPO) and mitigate long- and short-term damage caused by a working capital shortage.

Conclusion:


Keep in mind the working capital formula: financial assets minus current liabilities. Keep track of your working capital and solve the working capital problem. Regularly calculate your inventory turnover ratio, customer and supplier relationship loop, and accounts receivable ratio. Simply managing your cash flow can help you solve your working capital problems.


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