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Impact of Working Capital Management on the Profitability of Firms

By Finserv MARKETS - Aug 5,2019
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Impact of Working Capital Management on Profitability

For running a successful business, you cannot afford to be careless with the finances. Any negligence in managing your funds, be it the business loan that you have taken or the capital required to fuel your day to day business activities, can cause a negative impact on the business’ future prospects. Therefore, it is important that a businessman/woman should considerably emphasize on the company’s financial management, especially for the working capital.

What is working capital?

Working capital is the existing capital with a business that is utilized to take care of the company’s day-to-day activities. It is calculated as the difference between the company’s current assets and the liabilities payable. The amount of working capital with any company determines the ‘financial health’ of its business. Thus, more the working capital with the business, more its capability to expand its operations to earn handsome profits.

Working capital management is often the top-most priority of any company’s finance team, as in the case of any discrepancies in the allocation of funds, the company’s operational efficiency could come to a standstill. Efficient working capital management is also necessary for avoiding any default on paying company bills or EMIs on working capital loans.

Some financial experts believe that efficient working capital management and firm profitability are inter-related. This is because high investment in working capital might lead to a reduction in the profitability of the business, whereas a shortage of the working capital might lead to the company’s inability to meet its business obligations. To explore this point further, discussed below are the ways in which the working capital management affects the profitability of any firm:

1.Helps in building a smart investment portfolio

When you create a proper plan for your working capital, you can direct your funds into new business avenues or towards enhancing your existing business infrastructure. This helps build a smart investment portfolio that further contributes to the future profitability of the business.

2.Effcient allocation of resources

Deciding on which operational process to direct your funds is extremely crucial for business efficiency. However, when you have a detailed capital management plan ready, it becomes extremely easy to direct your funds to the required resources.

3.Maintains transparency in business dealings

With an effective working capital management system in place, you can help maintain 100% transparency with all your creditors and suppliers, thus establishing good business relationships in the long run. This earned goodwill can further help you gain several business advantages such ease in availing business loans, entering into new partnerships and collaborations and exploring new business avenues. All of this could ultimately affect the profitability of the firm.

4.Improved operational efficiency

Proper allocation of funds and an efficient business portfolio will definitely improve the operational efficiency of the business. This further leads to considerable savings on the time, efforts and financial costs of managing the business, while simultaneously ensuring higher profitability due to the business’ growth.

Thus, be it for a small start-up venture or an established business institute, the importance of working capital management is extremely crucial for a business’ profitability. A company must make sure that they hire proper financial experts who can devise efficient monthly/annual financial plans to efficiently direct the working capital towards proper business resources.

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Also read about the meaning of SME/MSME loan and its benefits.

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Bajaj Finserv Direct Limited ("BFDL"), erstwhile Bajaj Financial Holdings Limited is a registered corporate agent of Bajaj Allianz Life Insurance Company Limited and Bajaj Allianz General Insurance Company Limited under the IRDAI composite registration number CA0551 valid till 10-Apr-2021. BFDL also renders services to Bajaj Finance Limited (‘BFL’) and Bajaj Housing Finance Limited (‘BHFL’) (referred hereinafter as ‘Lending Partner’) in sourcing of customers, providing preliminary credit support activities, fulfilment services and post-acquisition customer services related to lending business. Registered Office: Bajaj Auto Limited Complex, Mumbai – Pune Road, Akurdi, Pune – 411 035 CIN: U65923PN2014PLC150522