Knowing what is working capital managementis essential for any entrepreneur. You should also know about some common mistakes that often result in this case and take steps to avoid them. It matters since working capital is the lifeblood of any business, helping it meet day-to-day expenditure and other essential costs. On that note, here’s looking at these mistakes and how to avoid them.
Working Capital Management- Mistakes to Avoid
To define what is working capital management, it can be said that it is the process of optimizing a company’s short-term assets and liabilities to ensure smooth cash flow, liquidity, and operational efficiency. It involves managing current assets like cash, inventory, and accounts receivable while balancing them against short-term liabilities such as accounts payable and short-term debt. Now, let us look at some of the mistakes as mentioned.
Sudden Expansion
If a business suddenly decides to grow and expand its presence, it may strain working capital. In case the growth plan is not backed by substantial cash reserves or financing options, it may deplete working capital and create liquidity challenges. Strategic financial planning is necessary to avoid excessive dependency on high-interest borrowing.
Poor Inventory/Production Planning
You should be accurate with your forecasting of business sales, inventory, and production. If it is off the mark, then you may end up locking your working capital in excess inventory or raw materials, limiting cash flow for daily operations. On the other hand, maintaining too little inventory may lead to stockouts and lost sales. Regular evaluation of sales forecasts and smart inventory management techniques, such as just-in-time (JIT) inventory, can help balance this.
Poor Cash Flow Planning
One of the biggest components of working capital management is proper cash flow planning. You should have a solid plan as to the cash flows that are coming in and the expenses that you are going to manage. Poor cash flow planning can arise not only from excessive spending but also from delayed receivables, unplanned expenses, and a lack of credit control. Implementing a proper forecasting system and maintaining a financial buffer can help businesses avoid cash shortages.
Excessive Debt
High debt repayments can also hinder working capital reserves for several businesses. Instead of avoiding debt entirely, businesses should focus on managing debt efficiently. Structured repayment plans aligned with cash flows and access to affordable credit can help businesses maintain liquidity while leveraging debt for growth.
Higher Credit Periods and Accounts Receivable Collections
Businesses often extend credit periods to get suppliers/clients on board. However, when this goes up to 45-60 days without proper planning, it may lead to poor cash flows and impact working capital. The focus should be on maintaining an optimal credit period and adopting strategies such as early payment incentives, invoice factoring, or automated follow-ups for timely collections. There should also be a proper collection process to prevent delays and reduce financial strain.
Not Accounting for Contingencies and Short-Term Liabilities
Businesses can have several liabilities in the short term, including lease payments, debt repayments, income tax, and operational expenses. Also, there may be sudden contingencies to deal with. Not taking these into account while planning working capital allocations may result in major financial strain. Maintaining an emergency reserve or securing flexible financing options can help mitigate unexpected challenges.
Signing Off
You should follow the above-mentioned tips to bypass common mistakes and manage your working capital wisely. Whether you run an ecommerce business as a part of an online seller community like Flipkart Seller Hub (FSH) or have any other online/offline enterprise, proper working capital management is essential to grow and succeed steadily in the long run.