Working Capital Management: Five Considerations for Optimization

They say ‘cash is king;’ it’s the lifeblood of any company. But what happens when the cash is tied up?

You’ve made a big sale; you’ve sent the invoice and now you’re waiting to collect the money to put cash in the bank. This doesn’t always happen right away. Days… weeks… months… can go by before you can collect, and you need to finance your business in the meantime. Payroll, buying raw materials, rent – it all adds up. Even moreso if you’re creating products: the manual labour, time, machinery, shipping, marketing are all costs incurred before the final product is produced. Do you know how long the cash conversion cycle takes? Are you long on inventory? How will you generate liquidity to fund growth? From a cash management perspective, are you staying nimble?

To operate effectively, you must understand the composition of your business’s working capital. Working capital is an important measure of your company’s financial health and liquidity; it is the amount of cash or funding available to readily manage the day-to-day expenses of your business. The way to calculate working capital is to take your current assets then subtract your current liabilities.

FIVE CONSIDERATIONS TO OPTIMIZE YOUR WORKING CAPITAL

Practicing prudent working capital management in the good times is one thing, but it’s increasingly essential if a business is experiencing some softness or weakness. As the business enters some headwinds and margins start to weaken, there’s pressure on profit and cashflow. Determining your liquidity runway – how long your cash will last, given your monthly burn rate – and what it would take to execute a turnaround, is key. It’s even more important that working capital is managed effectively. There are steps a company can take to improve its working capital:

1. RENEGOTIATE VENDOR TERMS – If you collect your receivables in 60 days but need to pay your vendor invoices in 30 days, you will always be left ‘holding the bag’, so to speak, for the interim 30 days (at least). Can you renegotiate terms with your vendors to be more in line with your payment schedule? Or at the very least could you discuss a 45-day window with them to give yourself a bit more breathing room?
2. ENHANCE YOUR COLLECTION PROCESS – being diligent and collecting on time could make the difference in cashflow optimization. A collection process where invoices are not piling up but rather being sent on time can have a huge positive impact on your business. It is important to also follow up on overdue payments promptly. One option to consider is if hiring another accounts receivable person could be of benefit. Sure, they require a salary, but if they help your team stay on top of invoicing, follow up with customers where needed and invoices are collected more regularly and on time because of their efforts, then that salary is worth the investment.
3. IMPROVE INVENTORY MANAGEMENT – it has been said that inventory ages like cheese. It’s no good if it sits there forever. To generate incremental cash, consider selling excess inventory quickly or look at alternative markets to sell it off. It might not generate the highest profits, but it will at least generate cash.
4. FOCUS ON FORECASTING – A common pitfall is that many businesses can be healthy and growing yet still run into financial problems because they didn’t plan properly. This is why forecasting is crucial. Of course, it is beneficial for when things might take a downturn, but it’s also to anticipate the cashflow needs of a positive change that may impact your business, too. Forecasting gives you the ability to prepare and plan growth appropriately, before you’re in the thick of it. For instance, onboarding a massive new account may take a considerable amount of cashflow and capacity. The new account could be great for your business in the long term, but it could tie up a lot of working capital, which you might not anticipate. Forecasting helps you determine if you can sustain new growth, or at least have a plan on how to fund it when the time comes.
5. REFINE REPORTING – Generating the right dashboards and reports helps a company stay on top of its working capital positions. Like forecasting, solid reporting gives you sound information in near real time, enabling you to react quickly. Efficient reporting of your working capital can also help uncover the early warning signs of an impending problem. The right reporting, applied in the right fashion, in a timely manner, might also expose an issue deep within your operations that you need to manage.

If needed, a professional team can also help you identify and implement new processes to enhance the management of your working capital. Evaluating working capital is part of the assessment that teams undertake when engaged in analyzing liquidity. Bringing in a turnaround professional or restructuring team means bringing in experience or capacity you and your team may not have, given that you’re focused on daily operations. They bring the knowledge of broader market trends, experience from assisting a variety of companies, and best practices from other industries. Essentially, these professionals can see what you’re not seeing, and make recommendations for improvement.

Working capital management can be complex but it’s a matter of managing your business’s health and liquidity effectively. By taking steps to evaluate your vendor processes and inventory management, and refine reporting, forecasting and collection processes, you can improve efficiencies and maximize cashflow because as they say, ‘cash is king.’