How Does Reduction Of Working Capital Help The Company Improve Their Cash Flows?

Introduction

Working Capital Management tends to be one of the most crucial impacts of the business because of the reason that it impacts the liquidity position of the company.

This is an increasingly important metric for the company because of the reason that it ensures that they are able to meet their day to day operational expenses in a smooth matter.

Working capital is a direct reflection of how well the company manages its resources, in addition to their ability to pay off their debts.

The reduction of working capital means that organizations are able to maintain and duly manage their resources in the sense that they are able to settle their debts in time while ensuring a quick recovery track record from the company.

Therefore, the management of working capital tends to be an increasingly important aspect that needs to be inculcated in the overall strategic decision making of the company.

How does working capital impact company’s cash flow?

Working capital, as mentioned earlier, is referred to as the capital that the business has in order to meet its running day to day operational expenses.

It mainly comprises of collection from accounts receivables from the company as well as payments to the accounts payables, as well as other relevant creditors of the company.

In this regard, it is quite rudimentary to ensure that companies are able to dissect their working capital structure, in order to determine and ascertain how changes within their working capital management can inevitably result in improved cash flows of the company.

See also  Equity Finance – 4 Advantages and 4 Disadvantages

It can be seen that working capital is broadly categorized into two broad categories, cash incoming and cash outgoing.

Cash incoming refers to the income collected from debtors. The average time in which debtors settle their accounts is referred to as an average cash collection period.

If this period is reduced, it automatically implies that the organization is able to collect their revenues from the debtors in a relatively quicker manner.

Hence, this means that they are able to get cash inflows at a faster pace as compared to their previous turnaround times.

On the other hand, cash outflows include payments that are made to suppliers.

Average Cash Payout time means the overall timeline in which the company settles its debts with their creditors.

This period needs to be improved by asking for more time to settle from their debtors.

These components collectively formulate the Cash Conversion Cycle of the company.

This means the average time it takes for the sales to be realized in the form of cash in the company’s bank accounts, and the major components that influence this metric are the average receivables duration and the average payables duration.

Reduction in working capital simply implies that the company is able to reduce its cash conversion cycle, so that at any given point in time, it has a reasonable amount of cash or liquid resources at hand to settle their operational expenses.

This considerably improves their cash flow, as reiterated under the following points:

  • Quicker customer turnaround times: Helps the company to collect money in a faster time, so that they have more resources at any given point in time.
  • Delayed payment times: Helps the company to hold on to the cash that they have earned, by delaying their expenses as much as they can.
See also  Accounting Entry for the Bonus Share Issue: Explanation with Example

Therefore, reduction in working capital greatly helps the companies to manage their cash cycles, and ensure that they are able to get cash in a faster manner.

The duration of the cash conversion cycle reduces with this management, and this directly impacts the cash flows in a productive manner.

This simply implies that at any given point in time, they have a considerable amount of liquid resources.

Conclusion

Therefore, there is no doubt to the fact that working capital management tends to have a great impact on the cash flows of the company.

In the modern-day and age, this is highly helpful for the company because it helps them to ensure that their liquidity is intact, and they are able to meet their expenses in a proper manner.

This can remarkably improve the company’s credit rating, and hence, this can help them sign on better deals with creditors because their metrics are favorable from an investor’s perspective.

Reduction of working capital cycles helps companies to realize revenues in a faster manner, so that they can avail early discounts on payments, without harnessing their reputations in any context because of unnecessarily prolonged payments.

Scroll to Top