Is your company tight on cash but you want to stay afloat and still grow the business? If YES, here are 21 best working capital management tips, strategies and techniques you can apply to salvage your business.
The concept of working capital can be traced back to old Yankee peddlers who would fill their wagons with different things and go around selling them. It involves three important processes. The first is that the peddler buys the goods on credit from a supplier, then he sells them and collects cash for a profit and then finally he repays the supplier of his merchandise to show that he is worthy of a new loan.
What is Working Capital Management?
These days, the basic principles remain the same but the definition has evolved since then. Working capital management refers to the way managers use short term financing to fund their current assets, such as cash and other cash equivalents, accounts receivable, inventory, prepaid expenses et al.
Current assets are a must have for any business, but managers should remember that there are costs associated with holding them. If a company can reduce its current assets without hurting sales, then profitability will inevitability increase.
Working capital management which is closely related to financial supply chain management concerns all companies, irrespective of their current situation and performance.
Companies buy goods and services from their suppliers, store the goods during and after the production process before selling them to their customers. This cycle takes up a high percentage of a company’s available liquidity. Usually a company only gets the liquidity back when the manufactured goods have been paid for.
This is exactly where working capital management will be applied. By optimizing various processes, the amount of tied up capital can be reduced. The company can then use the additional liquidity to make investments or fuel growth in new markets.
Without a doubt, the need for effective capital management cannot be overemphasized because it helps to increase the company’s profitability and also makes financial operations easier. It is sad to note however that a report by PWC discovered that since the financial crisis, that there has been a decrease on focus on working capital.
This will spell doom for a lot of companies in the long run. Here are the best working capital management tips, strategies and techniques you can use to secure your working capital.
21 Best Working Capital Management Tips, Strategies & Techniques
1. Manage procurement and inventory
Effectively keeping track of the amount of inventory you have at any given time is one of the hallmarks of an effective working capital management. This is because having more stock than necessary can put excessive pressure on the amount of cash the business has to run its other activities. Again, it can lead to damage of the product due to long storage if the stock is time sensitive.
On the other hand however, not having enough stock can result in a business losing sales to its competitors and ultimately damage to its image. In other to maintain an efficient inventory, you should take note of the items you purchase and the amount that you sell them. In other to do this, you will need to maintain an optimum level of stocks.
You can achieve this by maintaining a strong linkage of information and communication between the various departments and forecasting the possible rise and fall in demand so as to prevent your business from having too much or too little stock at any given time.
If a business does not know the level of stock that it has at any given time, then it will be close to impossible for the company to determine its optimum level and this could result to a lot of disadvantages for the business. You can counter this by taking stock of the number of products you have so as to monitor what you have at hand and justify the need to purchase more stock or not to.
2. Pay vendors on time
It goes without saying that being discipline in your payment process is a very vital part of the payable process. Studies and researches that have been made about working capital levels have shown that the biggest improvement comes from improved payable performance and reduced days payable outstanding (DPO).
Businesses that pay on time for the goods and service that they purchase have a better working relationship with their suppliers and have an upper hand when trying to negotiate better deals such as discounts and payment terms with their suppliers, should the need arise.
If you can keep your suppliers happy and stay in their good books, then you will be able to save money in the long run when it comes to getting larger discounts for bulk buying, recurring order and maximizing the credit period.
3. Improve the receivables process
In order to make the receivable process shorter, it is best that the business should have a good collection system in place. You should endeavor to send out invoices as soon as possible. Sometimes there may be lapses, bulky bureaucratic processes or inefficiencies that may result in delays in the process of sending invoices out.
If this happens, then the invoice process will have to be examined and reassessed in order to make it very streamlined and make it as effective as possible. Technology can easily be employed to improve electronic delivery of invoices and thus speed up the billing and collection process, and ultimately speed up the cash conversion process and cycle.
Furthermore, invoices should be scrutinized for any mistakes before they are sent out to the debtor so as to avoid delayed payment. You can also remind your debtors from time to time that they owe you and need to pay up as soon as possible.
4. Manage debtors effectively
To ensure that you have working capital available at any time, you have to make sure that money is coming into the business and on time too. If necessary, you may need to re-examine the credits and contracts that you have with your debtors so as to make sure that you are not giving them a very large window to pay up for the goods and services that they have purchased because this could have a negative effect on the cash flow of your own company.
The credit terms you signed with your debtors should be in such a way that it will benefit your company and your cash flow needs. You should endeavor to reduce bad debts to the barest minimum by implementing more rigorous credit checks and also ensure that effective credit control procedures are in place to chase late paying customers.
5. Make informed financing decisions
Working capital is interest free and comes with no condition and as such, it is the cheapest and fastest source of cash for a company. A study that was carried out recently was of the opinion that about sixty five percent of organizations do not have an immediate need to finance.
By putting their working capital in an order of preference, the company will be able to make strategic investment decisions which drives operational performance and efficiencies. On the other hand, not having enough operating liquidity due to the fact that the products you have are tied up as stocks, inventory and unpaid invoices can have a huge effect on cash flow.
6. Determine the business requirement
Determining the exact business requirement is the first step in deciding on the best way to fund working capital. Whether your business is starting out, in its first few years or you intend to expand your business, it will require different approaches and ultimately different financing solution.
Due to the fact that there are various methods that suit each stage of a company’s lifestyle, it is really necessary to regularly discuss plans and requirements internally with the senior management team and with external financial providers so that you can carefully plan and access your capital needs in accordance with the strategic objectives of the company.
In order to ensure that a company has an effective working capital management, it is very necessary to foster proper cash flow forecasting. When you are making a forecast, you should take into account the impact of essential factors like actions by your competitors, loss of prime customer, unforeseen event and market cycles. Cash flow forecasting is also advantageous in the sense that it helps to strengthen the balance sheet of a company and also stabilizes the finance that is available to the business.
8. Efficient capital management
By expertly combining your company’s operational and financial skills, you can be able to recognize and implement new strategies which will help it to generate cash in the short term. With the aid of competent company executives, responsible targets can be set for the organization, proper accounting of its performance levels can be made and can be catalysts and change agents.
9. Alternative financing
Sometimes taking up loans can be quite problematic for small business owners and as such, they may need to explore other alternative so as to meet their need for cash. Invoice factoring and working capital advances help in getting the cash faster. By using alterative techniques, you will be able to improve the overall cash flow of the company.
10. Shorten the operating cycle
Typically, the operating cycle of almost all businesses begins when purchase of raw materials is made with the conversion of account payable into cash. It goes without saying that if the operating cycle takes a long period of time, that a lot of working capital will be locked up in it. By shortening the operating cycle, a business can help to free up its cash faster and will thus improve the short term liquidity of the company.
11. Increase the volume of sales and reduce the expenses
The easiest way to improve the working capital position of any company is to simply reduce the cost of production. You will have to carefully scrutinize your expenses such as the amount of money that is being spent on business trips, rent, office stationary et al. so that you can decide the expenses that are not too important and cut them off without affecting output, thereby saving costs.
Increasing your sales revenue can also be another way to improve your working capital as long as the growth in revenue is greater than the increase in expenses required to generate it.
12. Invest in operations
Don’t just invest in operations, but also invest wisely in operations. At the time being, you may be putting your working capital into wrong areas of your business. For instance, if you are spending almost everything you make on production processes and very little on marketing and sales, will you find it very difficult to get new customers who are very much needed to increase your cash flow. Take you time to access your business and find out areas you can pump in funds for the greatest benefits.
13. Avoid wastage at all cost
At face value, it may appear that repairing an equipment is always the most cost effective solution to purchasing or leasing a new one but this is not always the case. The truth is that in some cases, you could be spending too much on repairs just to keep a failing piece of equipment that could be reducing your productivity.
This is where you have to take an introspective look at the financial numbers of your business. You may find out that the initial equipment purchase price and long term return on investment is more cost-effective than constantly repairing the old one.
14. Outsource certain operations
Outsourcing of certain tasks can be double advantageous in the sense that it may lead to cutting costs and will also allow employees to concentrate their efforts in other more important areas of their business. Outsourcing can also be embraced if you operate a small business with limited staff that doesn’t have enough working knowledge or skills to effectively work in specific business departments. Operations such as sales, customer service, accounting or technical support can be outsourced to other people or organizations.
15. Be accurate with your bookkeeping reports
One of the problems that businesses face when trying to keep track of their working capital is that they do not have the necessary data that is required to make an accurate report. They have no idea where the money is being spent.
By organizing your accounting department and having an accountant who can go over your ledgers, you can reduce inaccuracies and thus make better business decisions. Having you accounts software in the cloud can also really come in handy as you can talk with your accountant over the phone while you are both looking at the same set of accounts.
16. Have an efficient collection procedure in place
You should not just build you assumption on the idealistic mindset that your customers and clients will settle their debts as at when due. You should not fold your arms and wait for them. Send payment reminders and work to get late paying clients on a better payment schedule. While offering discounts to fast paying clients is another option, ensure that you are not giving out too many discounts that can have a negative effect on your cash flow.
17. Make it easy for your debtors to pay you: Some businesses do not offer credit card facilities because it to too costly and at the end it makes it difficult for people to patronize them because of the difficult payment options. You should try to make it very easy for your customers to pay up their debts and also it is not advisable to remove a method of payment that many people take for granted.
18. Create efficiencies that will help to complete jobs and tasks faster
This can be achieved by improving the work place so that tasks are completed at a much faster rate and thus improve cash flow. This could be by way of professionals working with dual screens, updating machinery or using great systems. For instance, if you are able to implement anything that cuts a task that takes four hours to two hours, then you should be able to being in twice the amount of revenue for potentially the same costs.
19. Make use of a cash flow budget
A cash flow budget is a very important tool that a business needs to have, in the sense that it helps in understanding when things need to be paid for and when you will have peaks and troughs in income. With this kind of information before hand, you can be able to either organize overdrafts for lean times or put aside cash for expenses.
Working capital optimization programs must not just be restricted to the finance function. It should engage the company’s entire managerial team. It is erroneous to believe that all capital management problems can be addressed by treasury alone. Appoint local working capital strategy leaders or champions across the organization.
You should never artificially adjust working capital levels by means of delayed payments to suppliers or indiscriminately stepping up collection activities in order to boost quarter or year-end performance metric. These under-the-hand approaches to increase working capital can pose consequences to the business because of the reaction that will arise from such actions.
By delaying working capital to vendors, you may be able to reduce working capital over the short term, but that improvement is likely to disappear over time as vendors adjust their pricing accordingly. Dynamic discounting is prevalent.
Incentivize people to achieve their working capital optimization targets by recognizing and compensating your staff appropriately especially at the managerial level.
20. Make concerted efforts to always optimize your working capital
There may be the temptation to take your focus away from working capital especially if the business is still in its early stages because it may not present the most immediate concern. Also in times when the business is in a crisis, there may be diversion of attention from working capital to other more “pressing” fields.
However, it should be noted that businesses will always pay for neglecting to focus on their working capital. Ignoring your working capital can significantly inhibit a company’s ability to grow and meet demand once the business rebounds.
21. Provide an added value to your suppliers
A lot of big organizations are now using web portals to deliver fluid and hassle free accounting transparency for all their suppliers and even their financial transactions too, irrespective of their location. You can as well come up with methods, procedures and techniques that can greatly add value to your suppliers.
22. Always look forward
Strategic planning is very important when it comes to maintaining your working capital. You need to carefully plan and assess your capital needs in the next week, month, quarter, year and so on. You should assess the needs that may arise such as, will you need to upgrade your software? Provide employee training? Move to a larger office? et al.
There are so many considerations to be made not to mention expenses that can suddenly come up. Plan accordingly and be prepared for any and everything. It should be noted that proper working capital management takes not only time but also effort. But however, it is critical if you want your business to grow and take advantage of new opportunities.