Working capital, defined as current assets minus current liabilities, is important to any business. Working capital is instrumental to help you expand your business, improve operations, pay short-term bills, and buy inventory. Inadequate working capital can be the kiss of death to your business, as you won’t have the funds necessary to grow the business. At times, negative working capital could even spell bankruptcy for your business.
CTG, a financial training company we previously published in our SmallBiz News (powerhomebiz.net), recommends five steps to improve working capital:
- Focus your activities: To get cash into the business as quickly as possible, the sales team should flag new sales to the accounting team so that the invoice can be issued earlier rather than later – particularly for larger orders that have a bigger impact. Instilling daily rather than monthly or weekly invoicing as a core business process can dramatically reduce debtor days. Also, take a cold, hard look at what you sell. Bring together your sales and marketing, operational and accounting staff to review regularly the success of your product or service offering. Too often businesses are complacent and focus on the revenues they generate from some of their activities, but ignore the costs associated with less successful activities.
- Leverage customer relationships: Customers often use excuses to avoid paying on time, saying that the invoice hasn’t arrived or is incorrect. Frequently, this only becomes apparent at the end of the credit period when chasing outstanding payments. It is more efficient to use those closest to the customer, who agreed the terms of the sale, to pre-empt these problems. Integrate calls into your customer service strategy to ensure the customer received their invoice and identify any issues.
- Secure and extend credit effectively: If you offer extended credit terms, make sure your salespeople don’t over-negotiate. Set affordable credit terms limits and ensure customers know you have robust debt recovery processes if those terms are exceeded. Also ensure your purchasing manager secures payment terms that at least match those you extend to your customers; entering into a purchasing co-operative or similar arrangement can also cut costs or offer better terms.
- Discount with care: Ironically, a successful sales team could have a negative effect on working capital if customers are offered discounts or extended credit terms. Ensure your salespeople know the limits – and impacts – of what they can offer and don’t over-negotiate in order to close a sale. In addition, discounting tends to have hidden costs that aren’t immediately apparent. Some accounting software packages will assume discounts are ongoing and consequently regular customers may pay a substantial part of their invoice at the right time, but leave some of the bill unpaid. Your business will then have to bear the cost of chasing that smaller amount.
- Manage inventory: Controlling stock effectively has a major, positive impact. Focus on overall stock levels to identify lines that aren’t selling rather than just ensuring popular stock lines are replenished, then lead the sales and marketing team in rationalising the number of lines you offer and focusing on your most profitable lines. Sourcing is also important. If possible, deal in consignment stock which can be held on your business premises but doesn’t need to be paid for until you sell it on. This lowers your costs while maximising revenues, as will properly planning and managing stock levels to accommodate peaks and troughs in demand.
This article published in the Bank of America website entitled 11 Ways Companies May Improve Their Working Capital Position, also suggests these steps on how your businesses can improve your working capital position by at least 20% over time:
- Get educated.
- Institute dispute management protocols.
- Facilitate collaborative customer management.
- Educate personnel, customers and suppliers.
- Agree to formal terms with suppliers and customers and document carefully.
- Don’t forget to collect your cash.
- Steer clear of arbitrary top-down targets.
- Establish targets that foster desired behaviors.
- Do not assume all answers can be found externally.
- Treat suppliers as you would like customers to treat you.
- Celebrate success in hitting targets.
Working capital is one of the most important concepts that you need to understand as you run your business. Understand this concept yourself, and not just rely on your accountant. The more you understand how your business is actually performing, the better you can develop strategies to respond to the market, competition and challenges your business is facing.
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