Why is Working Capital important for Small Businesses?

by | Nov 5, 2020 | 0 comments

By Author: Electronica Finance Limited

Need of Working Capital Management:
Efficient working capital management is an important component of sustainable growth. If a company runs out of money for running its day-to-day expenses, the production of wares and services will eventually stop. In such instance, the business will fail to cater to its existing customers and henceforth fail to acquire new ones as well. To restart production, the company will then tap into the company capital. While this step may offer a temporary respite, it will affect long-term stability by jeopardizing asset and equipment acquisition and maintenance.

Therefore, it is important to have a working capital management system in place, which can realistically assess the company’s working capital requirements, hence giving the managers and business owners enough time to come up with a solution.

Why is working capital so critical for any business?
The main reasons for working capital being so important are:

Enhances solvency: Working capital helps to meet short-term expenses, including purchasing raw materials, payment of salaries and meeting overhead expenses. Some of these payments cannot be delayed. Having sufficient liquidity helps the uninterrupted flow of production; thus, maintaining the solvency of a business.

Increased goodwill: When a business is able to promptly meet its regular expenses and pay salaries on time, it generates goodwill, not just internally with employees but also with suppliers and distributors.

Uninterrupted supply of raw materials: Quick payments ensure regular supply of raw materials. The inability to pay suppliers can result in production coming to a standstill.

Improved ability to face any crisis: Apart from the smooth functioning of business operations, working capital ensures that any financial emergency can be handled with ease. A business that has sufficient liquidity can cushion itself against unforeseen situations. Thus, the financing of working capital defines the financial health of a business and how smoothly it can operate under different circumstances.

Issues faced by MSMEs regarding working capital:
MSME is a strong contributor to the Indian economy but at the same time these enterprises or small business still faces challenges in accessing working capital.

A recent report by RBI says that the MSME sector has witnessed two major shocks – demonetisation and introduction of goods and services tax (GST). The introduction of GST led to increase in compliance costs and other operating costs for MSMEs as most of them were brought into the tax net. The MSME sector, however faces operational problems due to its size and nature of business, and is, therefore, relatively more susceptible to various shocks to the economy.

It is partly due to weak credit worthiness of micro and small enterprises in the country. Due to their weak economic base, they find it difficult to take financial assistance from the commercial banks and financial institutions. They are generally the last in the value chain to be paid.

MSMEs have no legal fall back for recovering dues as their reserve is completely invested. They depend on the working capital for any other expenses which can also cause balance sheet mismanagement as the statutory dues remain pending. This can affect the company’s CIBIL score.

Why is working capital loan an effective solution?
It is essential to remember that cash is king. It means that money (cash) is more valuable than any other form of investment tool. Assets and liabilities management is one of the most important things for business owners. Small businesses particularly should drive a perfect balance between the assets and liabilities to effectively carry on their daily operations, as they don’t have the capital to take up large losses. Appropriate working capital management is required to avoid any bankruptcy.

To avoid working capital scarcity, it is important to also not divert working capital money for machine or asset purchase, as it gets fixated there.

Insufficient working capital points to red flags in the company’s operations. When you need to find working capital for your business, a good way to give yourself extra support to meet your obligations is a working capital loan. Working capital loans are loans used specifically to finance the everyday operations of a business.

The cash that you don’t have to cover your short-term obligations can be compensated with a working capital loan. These loans are designed to pay for short-term expenses and are generally quickly approved. These loans can be exactly what a business needs to get a handle on covering operational expenses and making smart investments in the business in the near term.

Non-banking financial institutions are leading the race when it comes to working capital loans and financing. There is a simple reason for this, NBFCs have developed products and services which cater exclusively to the needs of small businesses; meaning, it is easier than ever to apply for a business loan, the verification process is quick and hassle-free, and the loans are approved faster.


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