Regardless of a business’ size or industry, working capital is essential to a company’s long-term financial health. Your working capital is cash and other assets that your business has on hand to cover operational costs like payroll, taxes, and bills. For this reason, learning how to manage your working capital is very important.
As such, properly managing a business’ working capital is important to ensure that the company maintains sufficient cash flow to meet every short-term commitment.
In calculating your working capital (Working Capital = Current Assets – Current Liabilities), you can solve for the dollar amount of capital you currently have. By doing this, you have a clearer picture of your company’s short-term liquidity.
How to manage your working capital
The work doesn’t end at finding the right amount of working capital. Taking loans is just a small portion of the equation. After you find working capital loans, it’s your job to use that working capital responsibly.
You must take measures to manage your working capital properly to avoid additional debts in the future. Proper working capital management aids a company’s profitability and ensures smoother financial operations.
#1 Maintain your working capital
Managing your working capital is all about making the best use of company activities to maximize the cash flow. Effectively maintaining your working capital begins with laying down proper key performance indicators.
KPIs help you measure specific areas of business performance. An example of a KPI you can keep track of is inventory turnover. You don’t want store managers holding too much of the wrong inventory on the wrong days.
In any case, the goal is to create a ratio that drives increased cash flow and liquidity.
#2 Be responsible with expenses
It’s tempting to ignore small expenses because they might seem insignificant. But finance experts confirmed that this is very unwise. Because there are times when small expenses mount up substantially and significantly and end up affecting your company’s working capital. The easy solution to this is to carefully control expenses.
Keep a careful eye on some expenses like travel and entertainment. They’re important, but keep it minimal. Cut back on costs if you have to.
#3 Pay your suppliers on time
Some may think little about their relationship with their suppliers or vendors, or the fact that it directly affects a business’ working capital. But paying your suppliers in a timely manner goes a long way in improving your cash flow.
Businesses that have lesser accounts payable outstanding have better relationships with their vendors. A better relationship with the supplier puts you in a better position to negotiate. And in business, effective negotiating is a staple.
In a good negotiation, you can secure more lenient payment terms, secure better deals, and get discounts. Keeping your suppliers happy can save you some money in expenses in the long run. This helps your working capital reserves.
#4 Improve receivables collection
A lot of companies have working capital trapped in a customers’ unpaid invoices. And if it’s a recurring issue in your business, you should consider adjusting your collection process. You need to secure what you’re owed in time.
The company needs to have a good collections system in place. An important aspect of working capital is to send out invoices as soon as possible. In auditing your invoicing system, you need to eliminate inefficiencies that may cause delays in sending invoices to debtors.
In fact, Deloitte recommends making use of technology to deliver invoices via electronics in order to speed up collection and billing. As a result, you are ultimately shortening the cash conversion cycle.
It’s also advisable to offer early payment discounts and encourage customers quick payment. It’s well-worth noting to ensure invoices are accurate before they are sent to your debtors. This is so you avoid delays in getting paid.
#5 Properly managing procurement and inventory
To make the most out of your working capital, the need for proper inventory management is evident. Excessive stocks place heavy burdens on your company’s cash resources. Meanwhile, insufficient stock results in the loss of sales and damages relations with customers.
When looking at inventory, remember to monitor what you buy — just as you monitor what you’re selling. The goal is to establish a favorable stock level. Periodically checking inventories are useful for monitoring the levels of different types of stock and alerting your finance department for any sign of understock or overstock issues.
For this reason, it’s important to control what you purchase. Also, consider introducing e-procurement.
These can reduce costs substantially. In a similar manner, choosing suppliers who have longer payment terms represent a huge boost to your business’ working capital. Automaton procurement involves a strict authorization process, which assists in reducing unexpected expenses and keeping your working capital in check.
#6 Reinvest in the business
One of the most important things to remember in managing your capital — especially for growing businesses — is to reinvest in your own business. Redirecting money back into your company is the best way to grow in the short-term.
Just be sure to leave room for regular expenses when you decide how much working capital to keep in hand at any given time.
Reinvesting in the business can come in the form of saving up for new equipment or marketing an event where everyone can see and interact with your brand and your products. You can make use of working capital loan to accomplish this and to help you cover other regular expenses.
Doing this can let your business grow and will be helpful in the long-run.
#7 Watch your inventory
An excessive inventory holding ties up huge amounts of working capital. Buying too much too frequently is the result of poor communication between company departments. This can be mitigated by quarterly or monthly inventory checks, and after doing this, it’s wise to follow up with the appropriate actions.
This is also important and advisable to avoid inventory shortages. Basically, it’s a balancing act that requires special attention to each product line.
#8 Track your debtors effectively
Another wise way to ensure that you have working capital is to make sure that money comes in on time.
Reevaluating credit terms and contracts with debtors might be necessary to ensure that you’re not providing your debtors with too big of a window to pay for services and other goods. This might impact your company’s cash flow negatively.
You need to ensure that the level of credit offered to your debtors is appropriate for the business’ cash flow needs. So, implement a stricter credit check if you have to. Impose an effective credit control procedure to keep debtors in place and go after late-paying customers.
#9 Make sound and informed financing decisions
Working capital and other selected forms of merchant finance come interest-free with hardly any conditions. As such, it’s one of the fastest and cheapest sources for business. In prioritizing your working capital, you can make strategic investment decisions, and it drives efficiencies and operational performance.
As mentioned in the very first tip, a great way to manage working capital is to have and keep track of your key performance indicators. This is because determining a business’ requirements is the initial step in finding the best method to fund the working capital.
So monitor your metrics carefully and meticulously to maintain your sound working capital management strategy.
#10 Emergency loans for short-term loans
But what if there are sudden fluctuations or shortfalls in your business’ working capital? The usual solution is to find emergency loans. These come in the form of working capital loan, a merchant cash advance, or a line of credit.
Hitting a hard spot is unavoidable for businesses. And since speed is essential, there comes a time when you need to seek out a lender who can provide you with the financing you need in 24 hours or less.
A business’ working capital is a critical factor of any business’ success. So whether your business is in its very first few years, or whether you’re making plans to expand, you will need stable access to working capital, as well as effective financing solutions should there be any unpredictable incidents.
And as there are different types of necessary financing for different stages of your business’ financial lifecycle, it’s important to discuss plans and requirements with your team or your department, and with external financial providers. Assess and plan your working capital needs and make sure they align with the company’s strategic objectives.