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The Relevance Of Knowing Your Working Capital

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Editor’s note: This is a basic overview of financial accounting that we have decided to share with our audience for several reasons.

Most of our audience works with large companies and this article provides, in part, some perspective into what your CFO maybe thinking and how they usually interpret the information they receive.

Remember, your CFO is the one person who usually sought out by all the C-level execs to explain the status and ramifications of planned (and unplanned) actions will have to the health of a company — your understanding of how they thing and what they may think and where they are coming from will reduce the miscommunications from the everday operations to those that view the company from a different perspective.

Though it doesn’t exactly fit our scope of publications, we have decided to publish this article like this for several reasons: the biggest being the deluge of requests that HR seems to be getting to provide reports for which, through no fault of their own, they are ill-trained and/or ill-prepared to complete.

The HRIS World is performing some research into this matter, where HR is suddenly under the scope of providing analytics when the scope of HR is actually to be an enforcer of policies and regulations that are usually handed down or over to them.

From our perspective, having HR perform analytics is much like having the local police department provide news reports at the end of the day — they are just too involved in what is happening to be objective in what they share.

Once we have our research completed, we will be providing a series of publications focusing on how this came about and provide suggestions on how to resolve this situation — without sending HR to accounting classes as well as to any schools of mathematics.

For this reason, the usual closing statement has not been imparted — you need to draw your own conclusions as to how this will impact your reporting and communications.

If you are a small business owner, you will probably find this article to be very beneficial for you in your communications with your accountant as well.

Working capital is at the heart of any industrial concern.

Even if you have large fixed assets, your business will not prosper if you do not have current assets.

When you have no current liabilities, working capital becomes equal to current assets, purely from the formula for working capital…

To understand working capital and why it is important to any industrial concern, you have to understand what are current assets, fixed assets, and current liabilities…

Current Assets : those assets that you can convert into cash within one year; this includes cash, bank, debtors, prepaid expenses, bill receivables and outstanding incomes.

Fixed assets, : known as property, plant, and equipment (PP&E), are assets and property which cannot easily be converted into cash; in most cases, only tangible assets are referred to as fixed.

Current Liabilities : liabilities that you would have to pay to respective parties. This includes outstanding bills, creditors, bills payable, bank overdraft, advance incomes, and outstanding expenses.

Investing in fixed assets only is not enough to run a business – fixed assets are not even part of the equation on working capital.

Current assets are important to the purchase of raw materials and to in meeting a company’s every day expenditure.

They are important for payroll, advertising, as well as maintaining fixed assets.

Importance of working capital

Working Capital Strengthens Solvency

When your working capital is adequate, you can operate your business smoothly.

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You can easily face any short-term financial problems.

Enhances Goodwill

When you have adequate working capital, you can make payments to your creditors promptly.

It helps create and maintain goodwill.

Easy-to-Obtain Loans

When you have adequate working capital, you have high solvency.

Your credit rating will also be good.

This makes it easy to arrange for loans from financial institutions and banks on favourable terms.

Ability to Stand-up to A Crisis

When you have adequate working capital, your firm can face crisis situations such as emergencies and depressions easily.

Small business payroll needs can also be met easily.

Raw material supply becomes regular

Quick payment ensures that raw materials are supplied on time.

To ensure quick payment, you need adequate working capital.

Working Capital in Service vs. Product Oriented Industry

How much working capital you need will depend on your industry and the circumstances of your business.

Working capital needs are different for service oriented industries and product oriented industries.

If you are in a service industry, you will not be carrying any inventory.

So your working capital needs are lower.

On the other hand, if you are in a product oriented industry, you will be carrying substantial inventory, unless you are practicing JIT or other management techniques.

So your working capital requirements will be higher.

It will also take you substantial time to manufacture and sell your products.

You will have to invest in raw materials, storage, transport, and more.

All these will increase your working capital needs.

In service industries, credit transactions are less while in manufacturing industries, it is very common.

For this reason also, product oriented industries need more working capital.

What Are Your Thoughts?

  As dry as financial accounting can be for many people, that does not elude from its importance. Even if you don’t see the connection, your CFO probably does — even if your report does not go directly to his or her desk. What other business matters do you believe your CFO has his or her professional eyes on?

  We have added several HR analytics books to our store — do you a preference we are not stocking? (http://store.thehrisworld.com)?

  What other topics can The HRIS World provide along this line (analytics, big data, accounting)?

Please share your thoughts with us and our audience in the comments section below! Or you can reach us directly from our contact page.

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Grace Becket is an expert associated with i3Group, a leading payroll service provider. i3Group's customized corporate payroll solutions have helped many blue-chip brands across various fields manage payroll obligations efficiently. You can reach Grace via email or by leaving a comment below...

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