The Significance Of Steady Working Capital for MSMEs

The Indian economy highly depends on the MSME industry, contributing 30% to the country’s GDP. The MSMEs are also responsible for employing around 110 million people. Despite the large-scale contribution, MSMEs often fail to maintain steady working capital for managing daily business operations.

Wondering what is working capital and its significance for MSMEs? Let’s dig in!

Working Capital- A Brief Overview

Working capital is essentially the difference between a company’s current asset and current liability. To put it simply, working capital refers to the available sum of money with an MSME to cover daily expenses smoothly. 

The ratio obtained from this calculation helps MSMEs measure the available liquidity and its ability to manage short-term obligations and other business-related operations. 

To maintain a perfect and positive net working capital balance, an ideal working capital ratio must weigh more towards current assets and less on current liabilities. 

Significance of Working Capital For MSMEs

Here is a list of reasons that focuses on the significance of working capital for MSMEs–

• Purchasing Plant And Equipment

Working capital is essential to cover the expenses of purchasing new equipment or plants. The price of this equipment is usually high, and managing such high-end expenses can be troublesome for any MSME. In such cases, if MSMEs opt for a working capital loan, they can easily manage the cash flow without depleting resources.

• Managing Stock

Inventory management is crucial for MSMEs as revenues depend on sales volume. While managing a business, MSMEs must ensure they have enough stocks or inventory to meet the demand of customers. If a customer particularly orders for a product and fails to get the same, it may hamper the reputation of the concerned seller and business/MSME.

Here, MSME must scrutinise the sales pattern and prioritise their inventory. MSMEs can stock up popular goods accordingly and eliminate overstock or understock issues by following sales patterns.

MSMEs can manage stocks or arrange working capital by opting for invoice discounting via the KredX platform. This online integrated cash provider offers hassle-free quick access to working capital to small businesses, MSMEs.  Small businesses can use unpaid invoices as collateral to receive instant working capital and ensure growth and expansion.

• Paying Wages

The significance of working capital in any business (whether small business, established business or MSME) is paramount. Apart from covering equipment or inventory expenses, MSMEs have to take care of other major expenditures, including paying employees’ salaries.

Therefore, MSMEs must keep aside a major portion of working capital, i.e. available cash for paying wages to employees to ensure consistent workflow. Further, to grow, MSMEs need to hire more employees and provide salaries to them as well. The work does not end here. To bring improvement in production, employees (both existing and new) are required to be trained in new technologies and working methods. For this, MSMEs need to arrange training sessions, and workshops, which may add up as additional expenses in a balance sheet. MSMEs with a perfect balance between current assets and current liabilities can manage these activities easily.

• Managing Seasonal Demands

MSMEs that depend on seasonal businesses for gaining maximum profit must ensure they have enough working capital to manage the demands. During these times, including festive seasons, customers tend to shop more, allowing MSMEs to maximise profit. 

Hence, MSMEs must prepare themselves for this time by stocking extra inventory and ensuring consistent workflow/ production flow. For this, MSMEs need to invest in advertisements, provide employee bonuses for extra work, clear creditor’s debt or manage the credit cycle by clearing previous debt. All these actions require money which can be only achieved through positive working capital. 

From the above-mentioned sections, MSMEs can easily understand the significance of working capital. Now, let’s move on to the section on the necessity of working capital management. Sounds similar? Let’s find out!

Necessity of Working Capital Management For MSMEs 

MSMEs need to follow a working capital management strategy to pay short-term liabilities within the due date. There are other objectives for working capital management, which includes generating profit. 

A higher amount of working capital means MSMEs need to earn more profit to get back the invested capital. Therefore, to ensure all the objectives or business goals are achieved, MSMEs need to follow positive working capital management.

Reasons to opt for a strategise working capital management:

• Ensure Higher Return: When MSMEs invest a high amount of money in production, they necessarily need the invested capital in the form of benefits. MSMEs can ensure higher profit only when they strategically invest portions of working capital, resulting in a high return on capital.
• Increase Liquidity: MSMEs with a high working capital have higher liquidity/assets than liabilities. The judicious management of working capital can lead to positive working capital and eliminate business shutdown or losses. Further, sound working capital management can help MSMEs survive during a crisis and restore business operations at favourable market conditions.
• Proper Utilisation Of Fixed Assets: MSMEs can effectively utilise fixed assets with an efficient working capital management strategy. Fixed assets often remain idle during the unavailability of basic business components, such as raw materials. However, with a robust cash management strategy, MSMEs can use these assets to purchase stocks as per requirements, pay creditors and manage business activities. In this way, MSMEs can avoid paying interest on borrowed funds and restore business.
• Consistent Workflow: Clearing debts of creditors or paying vendors timely is essential to ensure consistent workflow. If vendors do not get paid on time, they might cease to supply raw material, which may reduce and eventually lead to a halt in production as well as sales. These incidents will necessarily affect the reputation of MSMEs and customer relations. MSMEs can prevent these incidents by efficiently managing working capital and paying dues on time.

Bottom Line

Businesses, including MSMEs, require working capital for numerous reasons, such as installing high-tech equipment, purchasing raw materials, expanding business, paying salaries to employees etc. Working capital is an ideal parameter to measure the difference between current assets and current liability. Through the ratio obtained, businesses can easily evaluate the funds available to pay short-term liabilities. The earlier mentioned operations become easier when MSMEs adopt an effective working capital management strategy and practice the same. By doing so, they can maintain positive working capital and maximise profit.