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Jana Pfeiffer December 1, 2020 3 Minutes
Categories: Finance - Categories | Financing Guide

What is working capital?

Working capital, also known as net current assets in German, is the capital required by the company to finance current assets. Working capital is calculated by deducting current liabilities from current assets. Simply explained, a positive net working capital means that a company's current assets are covered by long-term liabilities or equity. A negative net working capital, on the other hand, shows that current liabilities exceed current assets. Therefore, by analyzing working capital over time, conclusions can be drawn about the company's financing and creditworthiness.  

What is it needed for?

Ongoing purchases should be covered with the help of assets required for operations. Longer-term projects, on the other hand, are tackled with the help of long-term forms of financing. The focus in the use of working capital is therefore primarily on achieving operational goals and financing day-to-day business. 

Working capital management

As already mentioned, working capital should be financed with matching maturities as far as possible. In addition to the financing structure, the amount and the relationship to other KPIs, such as net sales, are also decisive. An increasing working capital requirement in relation to net sales is a sign of inefficient liquidity management. As a result, this leads to a reduction in return on capital and in extreme cases can even lead to a liquidity shortage in the company. Therefore, working capital management planning deals with the optimal capital commitment, especially in growth or contraction phases of the company. Through a well-structured working capital management, a company can improve its scope in terms of solvency and free up money for the equity provider. 

There are three major levers that need to be considered systematically:  

  1. Management of payment targets
    With the invoice conditions at the supplier, the payment terms for the payment are also agreed. For new and small customers, it is often customary to grant only short payment terms, and for particularly important customers and regular customers, long-term payment terms. With suppliers from China, for example, it is quite common to pay 30% of the order value before the start of production and 70% only on collection. In general, negotiating a longer payment term can reduce working capital. 
  2. Inventory planning management
    The period between goods receipt and goods withdrawal, also known as the goods turnover time, also ties up crucial capital, so that a Optimization of lead times and production processes is crucial. Excessive inventories tie up capital that cannot be used for investments. Although sufficient stock is important to remain flexible and to be able to cope with fluctuating order numbers, it is also important to find an optimum here. 
  3. Receivables management
    If possible, the money tie-up between withdrawal of goods and receipt of payment should be kept as short as possible. However, the desire for short payment terms on the part of the supplier is offset by the customary nature of the industry or geographical regions. In e-commerce, for example, immediate payment is still the most common form of payment, depending on the sales channel. In any case, in the case of purchase on account, as little time as possible should elapse between the due date of the invoice and the grace period or reminder. In this context, it is worth mentioning an intelligent reminder system or the possibility of transferring the customer's claim to a Factoring companies to sell. In this way, losses on receivables can be minimized at the same time. 

All three measures can free up capital, which is why a regular review based on the relevant key figures (average time to payment of the supplier invoice, average inventory retention period and average period for outstanding receivables) should not be dispensed with.

What are the advantages of optimized working capital management?

By freeing up working capital, investments can be made in new projects. In addition, the credit rating index of a company is improved, so that access to external financing is granted. In addition, successful working capital management creates a cash culture within the company and reduces process costs.

Reducing working capital reduces the need for borrowing, increases profitability, improves business processes, and ultimately even increases shareholder value. 

Working capital management is therefore an important building block for efficient controlling and should be closely scrutinized in every company. 

But what can a company do when working capital is negative?

Although it has been shown so far what can be done when working capital is too high, it also happens that a company cannot cover current liabilities with current assets. 

This can be counteracted by increasing the company's own working capital or borrowing. Companies can shorten payment terms for customers, but this often has a negative impact on customer relations. Another option is therefore to borrow working capital. Here, there are various options that a company should consider. In addition to the classic bank loan, there are alternative lending providers on the market who specialize in the uncomplicated provision of working capital and provide assistance in the form of goods financing or a supplier loan for the supply of liquidity. 

For e-commerce businesses that need a flexible financing solution quickly, are we is exactly the right partner. We ensure the liquidity supply of online companies and help to provide working capital so that our customers can concentrate fully on their growth.

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