Like much in accounting, the term Working Capital may sound a bit odd (does that mean some capital doesn’t work?) but it’s important to understand and manage it to maximise financial returns.
Working Capital is the capital used in the everyday trading operations of the business and, at its most basic, comprises Trade Debtors (emphasis on Trade – there can be other Debtors too) plus Inventory less Trade Creditors (again, emphasis on Trade).
It’s the money (capital) the business lends to its customers to buy the business’s products (Trade Debtors), plus Inventory (the products the business has paid for but hasn’t sold yet) less the money lent to the business by its suppliers to buy their products.
Therefore, the lower are Trade Debtors and Inventory and the higher are Trade Creditors, the less debt and/or equity the business needs to fund its operations which helps to maximise Returns on Investment and Equity, the name of the financial game.
Minimise Trade Debtors by negotiating faster payment terms and ensure customers pay on time. Minimise Inventory by buying or producing it just in time to sell it. Maximise Trade Creditors by negotiating longer payment terms and don’t pay invoices until they’re due. All this and much more is made clear in these Financial Statements in Plain English online courses.
All that takes work – you have to work at your Working Capital.
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