Ask us how: Optimising Working Capital

Posted by Michael Derin
Published on October 16, 2013 under NSW Business Chamber Partnership

Following a phase of poor market conditions and consolidation, companies are now focused on growth strategies. To achieve this, companies will likely need additional financing which is often hidden in their own working capital.

Working capital can be hard for any business to manage, let alone small businesses that are working hard to build their businesses and need all the capital they can get to be competitive.

There are many different strategies business can implement to get the most out of their working capital.

UNDERSTANDING WHAT WORKING CAPITAL REALLY MEANS

Many small business owners mistake working capital for cash flow. There are many companies that are making a profit yet still don’t have enough available cash to pay their suppliers and creditors.

Working capital is current assets minus current liabilities, it is how much in liquid assets the company currently has to build its business, fund its growth and produce value for the owner.

Getting it right:

• Can mean the difference between growth and failure 
• Allows you to utilise your resources in the right way for helping your business
• Helps you avoid insolvency
• Allows you the flexibility to introduce new divisions, key products and/or services and continue on the path of success.

WHAT CAN A BUSINESS DO TO OPTIMISE THEIR WORKING CAPITAL

Optimising your working capital can mean the difference between growth and failure, allow you to utilise your resources to help your business and give you the flexibility to introduce new divisions, key products and/or services and help you to achieve success.

This is all very easy to say, but what most businesses struggle with is how.

Here are some general strategies if you find yourself with short or long term working capital issues:

• Put emphasis on the importance of real time information so you get a clear picture on your daily/weekly/monthly/quarterly working capital needs
• Actively work to reduce the payment collection period of debtors. This will your working capital requirement and will free up cash flow (have a look at my previous blog post on the cost of debt recovery)
• Better manage your expenses and creditor responsibilities to create better cash flow. Look at extending your payment terms with suppliers to alleviate immediate cash flow concerns or put in place payment arrangements for your liabilities
• Implement more effective stock control. Much of a small business’ (particularly those in retail and manufacturing) working capital is tied up in stock and a key issue is to find the optimum inventory level to minimise the cost tied up in inventories. Doing regular stock takes is also highly beneficial
   
• Speak to your bank manager about financing options to support your short, medium and long term liquidity issues. This may include debt financing or extending your overdraft facilities
• If your business is growing rapidly and this is creating short term liquidity issues, consider raising capital or attracting key investors to your business
• Reduce costs and increase income. Invest in your sales process and push new business to improve your short term and long term working capital issues.
• If your debtors aren’t paying on time, sign up to CreditorWatch to expose bad debtors and be alerted when the businesses you trade with fail to pay.

Businesses that can effectively manage their working capital have the opportunity to improve their cash flow, costs and services/products plus they can also become more agile and flexible against their competitors, which is very important when operating in an uncertain market.

MANAGING DEBTORS PROCESS

The best thing to do to manage your debtors is to put in place a standardised process that is focused on proactive follow up and regular telephone contact. This includes:

• Screening potential customers carefully
• Offering incentives for early payment
• Providing progress payment terms
• Set realistic credit limits
• Make one person responsible for this process to ensure consistency

MANAGING CREDITORS AND EXPENSES TO IMPROVE WORKING CAPITAL

It can be a tight rope balance act for businesses when it comes to deciding when they paying their expenses. Paying suppliers too quickly is a common error made by many businesses. However, you don’t want to damage the relationships you have with your suppliers by continually paying expenses late. Some tips include

• Use trade credit where available
• Calculate the benefits for making prompt payment to your creditor
• Negotiate extended payment terms to help free up cash flow
• Put in place payment arrangements for your liabilities.

EFFECTIVE STOCK MANAGEMENT AND OPTIMISING WORKING CAPITAL

Much of a small business’ working capital is tied up with stock and a key issue is to identify the optimum inventory levels to minimise the cost tied up with inventories.

It’s a fine balance between having enough stock to satisfy customer demands and being over stocked or being "caught out" with obsolete stock. Some important points include:

• Avoid overstocking: stock sitting on shelves for long periods of time ties up money which is not working for you
• Put in place procedures to ensure purchase ordering is controlled
• Try to improve sales projection accuracy
• Consider just-in-time capabilities, which aims to have the goods delivered just before or as they are required, this helps to minimise holding costs

When considering these techniques and strategies, companies need to recognise that each department has a unique mix of working capital components. The emphasis that needs to be placed on each component varies according to department. For example, some departments have significant inventory levels; others have little if any inventory.

Working capital management is not an end in itself. It is an integral part of the department's overall management. The needs of efficient working capital management must be considered in relation to other aspects of the department's financial and non-financial performance.