How to Ace Your Working Capital Management

Do you wish you had more cash flow to expand your operations and grow your company? For years leading businesses have known this secret: if you need more cash for your company, look inside your company first.

By refining the way you manage your working capital, you could free up resources and get your company back on track. But what does working capital management entail and how can you apply it to your business? We’ve got all you need to know, right here.

Get ready to learn how to ace your working capital management.

What Is Working Capital Management?

Working capital, also called net working capital, is the difference between your current assets and current liabilities. Subtract your current liabilities from your current assets, and what’s left is your working capital. But what is working capital management?

Working capital management refers to the strategies used to balance a company’s assets and liabilities to maximize working capital.

Why Is Working Capital Management Important?

Working capital management focuses on the company’s current balance of assets vs liabilities.

So, why is this so important for your company’s success and future growth? It allows you to make the most of your working capital so that your day-to-day operations are covered. This is essential to keep your start-up business afloat while you are building it up.

It also allows you to identify surplus resources and invest them more productively. This is crucial for growth, as it allows you to generate additional revenue streams which will improve cash flow and act as a financial safety net.

Working Capital Management Objectives

Working capital management doesn’t just support easier day-to-day operations. It allows you to target several vital objectives.

Ensure a Smooth Working Capital Cycle and Meet the Needs of the Business

The working capital cycle is the length of time it takes to turn net working capital into cash. The right working capital management strategies will ensure a smooth working capital cycle so you can easily meet your business’s needs. Read our guide to the working capital cycle to learn more.

Maintain Good Supplier Relationships

It is common practice to purchase raw materials or inventory on credit. Perhaps you purchased resources to produce and sell goods but your sales were disappointing. When you can’t pay your suppliers you may purchase from other suppliers on credit, and risk falling behind with payments there too.

It’s a vicious cycle leading to excess debt and a tarnished reputation. That said, when you effectively manage your working capital, you can reduce your liabilities vs assets and improve your creditor relationships.

Avoid Over-Indebtedness

It is just as common to take out short-term loans when you need some extra cash flow. These types of short-term debt are a prevalent feature in small businesses but can so easily become unmanageable.

Maybe you took out a large loan and then experienced a decline in revenue. You can’t cover your loan repayments so you take out more loans to meet these obligations. Soon, you become over-indebted, (meaning your total debt repayment obligations exceed your income).

Managing your working capital more efficiently can help you avoid the pitfall of mounting debts. If you need help consolidating debts, check out our ultimate guide to debt consolidation loans.

Leverage Available Working Capital for Investment and Growth Opportunities

Perhaps business has been going very well and you’ve had lots of sales. Your customers have all paid for their purchases on time. Indeed, you have surplus cash on hand.

This is good news, but only if you are putting this extra money to good use. Many businesses make the mistake of underutilizing their surplus funds.

Sure, you could leave it in the bank to accrue interest, slowly. Alternatively, you could pay off short-term debts ahead of schedule. But it may be better to invest the surplus into expanding your operations. With astute working capital management strategies, you can leverage working capital for investment and growth.

Components of Working Capital Management

The management of working capital is a multi-disciplinary practice. To maximize your working capital and get more out of it, you must approach it from various angles and apply various calculations.

Don’t worry, we’ve outlined it all for you. These are the essential components.

Managing Liquidity

Managing liquidity boils down to balancing your current assets and liabilities — in practice and on your balance sheet. If you’re new to the world of business, be sure to click here and learn the difference between a balance sheet and an income statement.

Start managing your company’s liquidity right from the start with these top tips:

• Set aside money when possible for unexpected future expenses and emergencies. If this gets used, replenish it as soon as possible. Keep this in an interest-bearing account, or an investment vehicle that allows quick access to funds when you need them.
• If you aren’t able to build up cash reserves for emergencies, secure access to a business line of credit. You only pay for what you use, when you use it. This can be a real lifeline when unexpected expenses arise, but it can also help you take advantage of new opportunities.
• Right from your first day of business, negotiate favorable payment terms with your suppliers. Furthermore, set clear guidelines for your customers regarding their payment terms.
• Keep accurate records and regularly analyze the data for patterns in your working capital. Measure the changes in your working capital to gain insights for improving your management of your working capital.

Managing Accounts Receivable

One of the company’s current assets listed on your balance sheet is your accounts receivable. The accounts receivable is the total sum of money owed to you by customers who received goods or services but have not yet paid for them.

It’s good to know that this money will come into the business shortly so you can pay your suppliers and meet your other financial responsibilities. But let’s face it, the sooner you get paid, the sooner this working capital is available and can make a difference in your company.

Make it easier for customers to pay by setting up digital payment platforms and early payment incentives.

Managing Accounts Payable

The current liabilities on your balance sheet include accounts payable. These are the short-term financial obligations you have toward lenders and suppliers you owe payment to for raw materials, parts, or inventory supplied.

There are two main ways to make your accounts payable work in your favor. You can delay paying them until they are due, or renegotiate longer payment terms, to improve your available cash flow right now. Or you can pay them off sooner for less.

Just as you can offer your customers discounts for early payment, your suppliers may offer you early payment discounts too. Also, ask them about any volume rebates or trade spend initiatives they may offer.

Managing Inventory

The way you manage your inventory plays a huge role in your working capital. Here are the primary reasons why:

• If you invest too much into inventory that is not in high demand, you will be overstocked and have less working capital available.
• Conversely, if you fail to meet the high demand for certain types of inventory, you will be understocked and lose sales that would have increased your working capital.

As the above examples illustrate, without proper management of your working capital your inventory can work against you. So check your historical sales data, do the necessary market research, and stay up-to-date with consumer trends.

This will give you insights into what inventory you need more or less of. Remember to take seasonal factors into account.

Managing Short-Term Debt

Managing short-term debt is the key to staying up-to-date and on track with your financial obligations. If you have any business loans you’re paying off, always pay them on time. This will help you to build up a history of good business credit.

If you are already paying off debt, avoid incurring more debt unless you know the extra funding can ultimately lead to more sales or business growth.

Working Capital Management Ratios

Managing working capital means managing the relationship between current assets and liabilities. And to do that, you will employ various key ratios. These working capital ratios include the current ratio, the collection ratio, and the inventory turnover ratio.

Current Ratio

The current ratio, also known as the working capital ratio, is a liquidity equation that divides current assets by current liabilities. The working capital ratio reveals whether a business can meet its financial obligations with its current assets.

Collection Ratio

The collection ratio, sometimes referred to as the receivables turnover ratio, measures how efficiently a business manages accounts receivable. To work out your collection ratio, divide your total accounts receivables by your average daily net credit sales.

Inventory Turnover Ratio

The inventory turnover ratio, also known as the stock turnover ratio, measures how efficiently a business manages its inventory. To calculate your inventory turnover ratio, you must divide the cost of the goods you have sold by the average inventory cost.

Effective Strategies for Managing Working Capital

As you can see,  working capital management touches on many aspects of your business. When you master the art of managing your working capital, you will increase liquidity, boost profitability, and ensure seamless operations. All of this will lead to improvement in your company’s financial health.

These strategies will help you manage working capital better.

Increase Cash Visibility

Increasing your cash visibility is a positive step towards improved working capital management. One of the easiest ways to do this is to automate your financial record-keeping.

With automated financial software, you can pinpoint where all the cash flow is coming from or going at a glance, and can easily cross-check records. It also ensures greater accuracy, which is a must for stress-free payment schedules as well as tax compliance.

Refine Cash Flow Forecasting Accuracy

Cash flow forecasting enables you to estimate future cash positioning by measuring the influx of cash across a specific period. When you can predict how much cash flow your accounts will experience, you can make better financial decisions and streamline your budget.

But how do you refine cash flow forecasting? Become an amateur detective. Do some research on your own business. Every company has peak and off-peak seasons when their cash flow in or out noticeably changes. Detect these highs and lows, and use these patterns to predict future cash flow patterns.

Improve Accounts Receivable Management

Improve your accounts receivable management. Your accounts receivable determine your cash flow and liquidity. Therefore, you must practice accurate bookkeeping to ensure that all information is precise and easy to review at any time.

Accounts receivable management also requires a proactive approach. Outline clear billing procedures for your customers and set firm credit collection policies. Make it easy for your customers to pay you electronically and set automatic reminders for customers who tend to leave payments late.

Execute Scenario Analysis

Do a scenario analysis. This is a technique that involves estimating the expected value of your working capital under different conditions or scenarios. And yes, that includes worst-case scenarios too. Indeed, you will learn more about how future-proof your business is from worst-case scenarios.

Here’s an example: your traditionally late-paying customers go out of business themselves and suddenly become non-payers. Or your suppliers increase the prices of your raw materials. How will these changes affect your current assets and liabilities, and therefore your working capital?

Eliminate Unnecessary Expenses

Want to have more available working capital in your company? Eliminate unnecessary expenses. Look for potential causes of financial waste, such as redundant practices, outdated machinery, or unnecessary departments.

There are many ways you can start saving money in your business right now. Look for cheaper travel options for business trips. Revise your perks and rewards system for employees. Look for more affordable raw materials suppliers.

When you put your mind to it, you will reduce more expenses, and free up more working capital than you dreamed possible.

Shorten the Cash Conversion Cycle

The cash conversion cycle is a measurement of how many days it takes to convert inventory into cash flows, through sales. When the cash conversion cycle is too long, it could mean that there is too much inventory, or that customers aren’t paying for their orders quickly enough.

Shortening the cash conversion cycle means selling the inventory on hand faster, and getting paid for it sooner.

Shorten your cash conversion cycle by minimizing excess inventory and implementing just-in-time inventory practices. To adapt to a just-in-time approach, reduce the amount of excess inventory you keep. Order smaller shipments of materials and parts to produce goods and replace inventory as needed.

While this does not translate well into mass-producing manufacturing plants, it can be very effective for shortening the cash conversion cycle in smaller manufacturing businesses.

Monitor Balance in the Revolver

A revolving credit line remains available even as you make payments on the balance. This can be very helpful for accessing funds for day-to-day needs. Conversely, it can also mean that you never get out of the cycle of debt.

Keep track of the balance of your business’s revolving credit. Use it for essential business purchases only. This will allow you to keep the balance low so it’s there when you need it for emergencies.

Conclusion

Working capital allows you to cover day-to-day operations,  meet your short-term obligations, and even make profitable short-term investments.

Efficient working capital management will help you maximize and optimize your company’s working capital. If you need to boost your company’s working capital position more quickly, we have the solution.

At E-Boost Partners, we help small businesses access the funding they need to increase their working capital. We also offer merchant services that make customer payments affordable and convenient, streamlining your entire operation. Contact us today for tailored solutions to your financial needs.