Improving working capital allows companies to more efficiently meet their operating demands. These demands include wages, accounts payable, facility expenses, payment to suppliers for raw materials to name just a few. Without working capital, a company may find itself in a cash flow shortage situation. Cash flow shortages often lead to taking on debt out of necessity to cover cash shortfalls. Thus, leveraging up the company's balance sheet. With enough debt, the company will find it is more difficult to take out new loans. It's a negative feedback cycle. Ultimately at some point the company is no longer able to find cash, defaults of its obligations and files for bankruptcy.
Improving working capital helps to keep companies ahead of the curve when it comes to cash management. The way to do this is through technology and strategy. In this article, we'll discuss 6 hacks that improve your working capital.
1. Decrease The Gap Between Accounts Receivable And Payable
Many companies allow accounts receivable to extend out past accounts payable. In this situation, supplier invoices come due before customer payments are received. This means the company is financing customer payments. For example, if supplier invoices on average are due 30 days after delivery of materials and customer invoices are due net 60, there's a 30-day gap the company must somehow cover (i.e., finance).
Covering the above gap means digging into working capital, leaving less money for operational expenses. The way to improve this gap is to decrease it. By decreasing customer net terms and increasing supplier due dates, the company can close the gap between accounts receivable and accounts payable. That might not happen all at once. Newer customers may be put on net 30 terms. After a trial period, they may go to net 45, which is the maximum net terms the company has established. That's a 15-day reduction from the previous net 60 terms.
For better due dates with suppliers, the company will have to negotiate terms that extend due dates from 30 to 60. By ensuring on-time payment, the company may be able to decrease terms by a few days. Additionally, by paying a day or two before the due date, the company may be able to have terms extended to net 45.
The above is part of a working capital strategy method known as the working capital cycle. Next, we'll look at a hack that uses technology to improve working capital.
2. Automate Accounts Receivable
Manually handling the entire accounts receivable process is labor intensive, inefficient and error-prone. Employees make mistakes, they miss work, they may not work as fast as they should. A key employee who quits means you need to hire more people and train them on the entire manual process. If the employee quits suddenly without a transfer of knowledge taking place, this can put your company in a bind.
Automating accounts receivable not only provides efficiencies for your company but also for your customers. With an automated A/R system, customers receive invoices digitally and can pay the same way. This improvement removes employee involvement from the process. There is still some manual involvement but it is drastically reduced.
Mistakes in the manual management of A/R can cause delays in getting paid. Automation can help cut out such mistakes and streamline the entire A/R process.
3. Quickly Resolve Disputes with Customers and Suppliers
Disputes aren't fun but they are inevitably part of doing business. With so many moving parts and variables, the chance that some discrepancy occurs is high. Resolving them quickly can mean maintaining great relationships, getting paid within a reasonable amount of time and saving on potential expenses and legal cost.
To improve your chances of avoiding disputes, go through your customer and supplier facing policies and agreements. Look for the following:
- What's missing
- What isn't clear
- Where potential areas for conflict exist
It can be difficult to know ahead of time but brainstorming what can go wrong will help to make your policies more conflict-proof. Of course, improving such policies means on-the-job training (i.e., getting involved with conflicts). Experience is a great teacher. After every conflict, go back to your policies and agreements to make sure that scenario is thoroughly covered.
Resolving disputes quickly will save time and money, especially when any dispute goes to court. Disputes tie up employee time and company money, all of which will deplete working capital. The sooner a dispute is resolved, the less impact it will have on working capital.
4. Better Inventory Management
Inventory management can be a very complex process. Using software to manage inventory will have the same positive impact as using software to manage A/R. Through inventory management software, you can better identify items that are not selling, avoid overstocking, and know when to order hot items, taking advantage of JIT order management.
If you own retail locations, having your POS (point-of-sale) integrated with the inventory management system is critical. The POS will track items sold and feed that information back into the inventory management software, providing real-time updates on all items.
5. Analyze Expenses
With enough analysis of expenses, you can usually find areas where cost can be reduced or cut out completely. Starting with fixed cost, go through all of the monthly subscriptions to various products and services. You'll likely find that some are not even being used.
When it comes to fixed costs such as utilities and rent, try to negotiate better rates. An early renew on your facility lease might lead to cost savings. Outlaying money ahead of time for an early renew will impact working capital but the long-term positive impact may be worth it.
Variable costs are often associated with the production of a product or service. Reducing these cost means negotiating better rates with vendors. If you've increased production and are using more of a specific raw material, you may qualify for a rate reduction.
6. Reduce Debt Servicing Expenses
Debt can be unavoidable for startups and some mature businesses. For those businesses, it's a required part of working capital. But are you paying too much in interest or regularly taking out loans, which require high origination cost?
If your financial structure has improved, you may be able to negotiate better rates with lenders. If existing lenders won't budge, check current rates with other lenders.
Is your line of credit charging too much interest or is it at an adjustable rate? See if you can get a fixed rate line of credit without any origination fees.
Reducing the above debt service expenses will drop right into working capital since they have an immediate impact.
While cash flow is the lifeblood of a company, working capital allows the company to perform everyday functions through the use of that lifeblood. There are levers that can be pulled to improve cash flow and a different set of levers to improve working capital. Once money comes into the company, it is up to working capital management to distribute that money efficiently. Working capital management is an ongoing process, just like any other cash management process that seeks to improve a company's overall use of its finances. In this article, we've seen how strategies and technologies can lead to improved working capital management.