Importance of Working Capital

Importance of Working Capital

Importance of Working Capital

Working capital is the lifeblood and nerve center of business. Working capital is very essential to maintain the smooth running of a business. It is important because it is a measure of a company’s ability to pay off short-term expenses or debts. No business can run successfully without an adequate amount of working capital. The most important positions for effective working capital management are inventory, accounts receivable, and accounts payable. The needs for working capital vary from industry to industry, and they can even vary among similar companies.

The importance of working capital are as follows:

(1) Strengthen the Solvency

The ability to meet short-term obligations is a pre-requisite to long-term solvency. Working capital helps to operate the business smoothly without any financial problem for making the payment of short-term liabilities. The purchase of raw materials and payment of salary, wages, and overhead can be made without any delay. This could include payment for a purchase of raw materials, payment of salaries, and other operating expenses. Adequate working capital helps in maintaining the solvency of the business by providing an uninterrupted flow of production.

(2) Enhance Goodwill

Sufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill. Firms with more efficient working capital management will generate more free cash flows which will result in higher business valuation and enterprise value. Goodwill is enhanced because all current liabilities and operating expenses are paid on time.

(3) Easy Obtaining Loan

A firm having adequate working capital, high solvency, and good credit rating can arrange loans from banks and financial institutions in easy and favorable terms.

(4) Regular Supply of Raw Material

Quick payment of credit purchase of raw materials ensures the regular supply of raw materials from suppliers. Suppliers are satisfied with the payment on time. It ensures a regular supply of raw materials and continuous production.

(5)Helps in Earning Short Term Profits:

Sometimes it is seen that the enterprises keep a heavy amount of funds as working capital which is far over and above the required level of working capital. So by correctly preparing the required working capital those extra funds could be invested for a short span of time and could create value in the profits of the enterprise.

(6) Smooth Business Operation

Working capital is really lifeblood of any business organization which maintains the firm in good condition. Any day to day financial requirement can be met without any shortage of fund. All expenses and current liabilities are paid on time.

(7) Improves Creditworthiness of Entity

When the enterprise has adequately planned their working capital requirements, they will surely pay the payments to vendors and other creditors timely which improves their creditworthiness which could help them to get the funds as and when required easily.