The mechanisms used to control working capital involves adjusting the components of working capital, which are current assets and current liabilities. A company can increase working capital by either increasing current assets or decreasing current liabilities, or both. Let’s use this example:
Suppose we have current assets of $100,000 and current liabilities of $40,000. The working capital will be 100,000-40,000 = 60,000. Let’s say the company’s employees worked hard to generate more cash of $10,000 through sales. This means that the current assets will increase to $110,000 and WC will rise to $70,000 (110,000-40,000). Some of the mechanisms that a company can use to control the components of working capital are:
Cash Management: this involves collecting and managing cash flows to ensure that the cash balance is enough to run business operations. A company can increase working capital by looking for ways to generate more cash.
Inventory Management: inventory management refers to the process of controlling inventory or stock by ordering, storing, using, and selling them. As part of current assets, increasing inventory leads to increased working capital. Inventory can be increased by ordering more raw materials. However, the firm should ensure that it has only enough stock to meet existing and future demand.
Debtors Management: This involves collecting debts in time and avoiding bad debts. A company can manage debtors by discounting the debt through a bank. A company can also use appropriate credit policy and create the right credit terms to attract customers while at the same time minimizing bad debts.
Financing Management: Financing management involves choosing appropriate sources of financing, which will ensure that there is a good flow of cash in the company. Financing options such as short term and long term bank loans can affect the components of the working capital.
Operations Management: Operations management involves controlling the processes involved in producing goods and delivering services to customers. Business operations should be managed well to achieve efficiency, reduce wastes, and ensure proper utilization of current assets to meet pay the current liabilities.