7 Practical Strategies for Effective Working Capital Management
What is ‘working capital'? And how do leaders effectively manage it?
This refers to managing the company's short-term assets and liabilities, so the business has the liquidity to meet short-term obligations and fund its day-to-day operations.
Here are some practical strategies to strengthen a business through astute working capital management.
1. Get to Know Your Working Capital Ratio
The Working Capital Ratio (or current assets divided by current liabilities) gives a good indication of the liquidity position. A ratio above 1 indicates enough assets to cover short-term liabilities.
For example, a manufacturing business may set a target ratio of 1.5 or higher. If below that level, corrective action is considered, like adjusting inventory levels or renegotiating supplier payment terms.
2. Understand the Impact of Stock Levels
Excess stock ties up cash. Minimise ‘carrying costs’ while ensuring there’s stock to meet customer demand.
For example, a retail chain uses inventory management systems to track sales data in real time. Understanding sales patterns and adjusting inventory accordingly, reduces excess stock which can greatly improve cash flow.
3. Renegotiate Payment Terms with Suppliers
Some suppliers will agree to more favourable payment terms or even discounts to retain your business. Extending payment terms gives more time to pay bills and improves cash flow.
For example, a construction company extended payment terms with its main supplier, resulting in improved cash flow and the ability to fund immediate projects to completion.
4. Encourage (or Incentivise) Early Payment by Customers
Ensure customers pay promptly and consider incentives for early payments, including discounts. Invoices must be sent on time so customers have no excuses!
For example, a marketing agency implemented an automated invoicing system that sends invoices immediately after projects are completed. The average collection period became 30% faster, improving cash flow and reducing bad debt.
5. Manage Accounts Payable
Delay payments to suppliers without harming relationships. Be aware of late payment penalties that could offset any benefits.
For example, A technology company takes advantage of grace periods offered to loyal customers by certain suppliers resulting in improved working capital without disruptions to its supply chain.
6. Utilise Accurate Cash Forecasts
Cash flow forecasts help predict cash needs and shortfalls, so they can be addressed well in advance.
For example, a restaurant chain forecasts cash on a quarterly basis. Seasonal shortfalls are identified and managed by adjusting marketing and labour expenses.
7. Consider Financing Options
Credit or short-term loans increase working capital, used to cover short-term obligations or growth.
For example, a retailer experienced delayed customer payments. Securing a line of credit enabled quick access to funds for immediate financial obligations and to maintain smooth operations.
Use these strategies to improve the understanding and management of business working capital, ensuring the liquidity needed to operate efficiently and grow.
Need help managing business cash flow? Contact Alliott NZ's Chartered Accountants and Business Advisers in Auckland on 09 520 9200.
