The growth of any business is something which is thrilling. More customers, increased sales, more employees, bigger orders, and moving out into new markets is proof of growth. However, there is one area in finance where the growth of a business becomes quite problematic. That problem is the issue of working capital. A business could be making plenty of money and be highly profitable but would find it hard to pay its employees, suppliers, landlords or pay anything else due to high levels of cash tied up in current assets such as unpaid invoices or inventories.
Good working capital management will help in ensuring that a company has sufficient cash available to pay for its operations and use the funds available to it in an efficient manner.
Working capital management deals almost exclusively with cash, accounts receivable, inventory and accounts payable.
What is Working Capital Management?
Working capital can be defined as the difference between the current assets and current liabilities of a firm. Current assets include cash, receivables, and inventory, while current liabilities include supplier payables and many other obligations. Working capital management involves the management of working capital in order to help the business meet short-term obligations, and facilitate growth.
It’s not about keeping as much cash as possible. Cash may be idle and unused, while there could be not enough cash to run operations.
The best way to do things would be balancing liquidity, profitability, and growth.
Why Growing Firms Need Better Working Capital Management
Sales growth leads to increased working capital. Let’s take a look at an example:
A firm gets a huge order from a client. In order to satisfy his demand, it needs to buy some materials, hire workers, produce, and deliver goods to him. The client will pay in 30, 60 or even 90 days.
Money has been paid out, however, the income hasn’t turned into cash yet. And doing such things on a regular basis may lead to problems despite rapid growth.
That’s why the working capital needs to be managed as a growth strategy.
Optimize Your Accounts Receivable Function : Another way of optimizing your working capital management is speeding up customer payments. A sales transaction is useless until the client makes the payment. First of all, review your customer payment terms and receivable aging frequently. Classify invoices into:
Current
Overdue – 30 days
Overdue – 60 days
Overdue – 90 days plus
Solution: Establish an Effective Collections Process
Define payment terms prior to initiating the business relationship with the customer. Invoices should be sent right away following the delivery of the product/service. Instead of waiting for the invoice to become overdue, send reminders before the payment due date.
Collections performance can also be delegated to a certain person and monitored via the dashboard. Monitoring Days Sales Outstanding (DSO) metric will allow managers to know how long it takes for a company to convert sales into cash.
It is necessary to not only increase sales but to turn those sales into cash quickly.
Reduce Excess Inventory : Inventory takes up a considerable portion of working capital.
This means that having excess inventory means the company has cash invested in the inventory rather than in its business processes. Excess inventory can also result in such negative consequences as:
Storage costs
Obsolescence
Damage
Insurance costs
Pressures for discounting
On the other hand, too low an inventory can also bring about stock outs and lost sales. So, what one should do is reach the balance.
Solution: Evaluate Inventory Performance
Evaluating inventory regularly and finding out:
Fast-selling items
Slow-selling items
Dead stock
Obsolete inventory
Using sales trends and statistics will help make better purchasing decisions. Demand, seasonality, lead time, and the sales trends of the moment should be taken into account.
In many companies, evaluating inventory days or Days Inventory Outstanding gives important information on how fast inventory is turned into sales.
Negotiate Supplier Payment Terms : Not only does working capital management mean quicker collections. It also means management of when money goes out of the business. For instance, if your clients pay you in 60 days and you pay your suppliers in 15 days, you have to finance the gap.
Solution: Reassess Supplier Terms
Talk to important suppliers regarding their payment terms. Depending on the power dynamic between you and them, you can negotiate for longer terms that would match up better with your collection cycles from customers.
But long-term payment arrangements must be done responsibly; the idea is not to drag out payments but to develop an effective cash conversion cycle. And don’t forget to avail of early payment discounts when it’s financially viable.
Develop a Rolling Cash Flow Forecast : One of the best practices in working capital management is having a constant cash flow forecast. Cash flow forecast will help you find answers to questions like:
How much cash do we have next month?
What payments are due?
What collections can we expect?
Can we afford our investments?
Solution: Forecast Cash Flow on a Consistent Basis
Instead of making a cash flow statement once a month, try creating a rolling forecast of it. Review:
Cash Inflows
Collections
Sales
Loans
Investments
Other inflows
Cash Outflows
Wages
Supplier payments
Rent
Taxes
Loan payments
Capital expenditures
Comparing expected cash flow with the actual cash flow can also help with forecasting improvement over time.
Monitor the Cash Conversion Cycle : The Cash Conversion Cycle (CCC) can give businesses an idea about how long their cash stays tied up in operations. It combines three critical components:
Inventory sales speed
Speed of customer payment
Businesses’ paying suppliers speed
The lower the CCC, the more rapidly companies can use their cash flow again; however, there is an optimal level that varies by the nature of the business.
Solution: Calculate DSO, DIO, and DPO
Management needs to track the following indicators:
DSO (Days Sales Outstanding): How long it takes to get paid.
DIO (Days Inventory Outstanding): How long inventory sits before selling.
DPO (Days Payable Outstanding): How long it takes the company to pay the supplier.
By tracking all these points simultaneously, management gets a clear picture of working capital performance compared to cash balances alone.
Stop Using Only Excel Reports : As companies evolve, working capital information starts coming from various sources:
Accounting system.
Bank account.
Sales system.
Inventory system.
Customer database.
As teams manually consolidate data in Excel spreadsheets, it takes much time, and errors might appear.
Solution: Automate Working Capital Reporting
Using finance automation tools and interactive dashboards will let the management bring relevant information to one place. For instance, the working capital dashboard can include such items as:
Cash position
Receivables aging
Payables aging
Inventory
Trends of collections
Trends of payments
DSO
DIO
DPO
Cash conversion cycle
This gives management a faster way to identify cash flow risks and take corrective action.
Incorporate Working Capital into Growth Strategies : Every growth strategy needs to take working capital into account. Whenever a new product launch, market expansion, or new customer order is being considered, the question needs to be asked:
What additional working capital will be needed for this growth?
More sales may mean that you need to have more inventory, employ more people, pay suppliers more, and have longer periods between invoicing and payment from customers.
Solution: Include Working Capital in Forecasting
When creating budgets and financial forecasts, always consider the amount of working capital that will be needed to fund the anticipated growth. It will help businesses know whether their growth can be financed by existing cash or whether there will be a need for further financing.
Plan in advance rather than finding out that there was no way of funding your growth after making a decision on expanding.
Have Sound Financial Control Measures : Lack of sound financial control measures can erode working capital without businesses realizing it. Some examples include:
Unauthorized expenses
Double-invoicing
Errors in invoicing
Unrecorded customer advances
Delayed collections
Failure to reconcile bank statements
Solution: Have Standardized Finance Processes
Establish a process for:
Invoicing
Collections
Procurement
Payment processes
Approval of expenses
Bank reconciliation
Credit limits of customers
Automation can be used to eliminate any errors and ease tracking of the various processes.
How BudgetMaccha Can Help
Managing working capital becomes increasingly difficult when businesses expand. Often founders need more than just accounting information about their finances to help make important decisions. BudgetMaccha can assist businesses to enhance their finance department through:
Working capital management
Cash flow reports
Management Information System (MIS) reporting
Power BI dashboards
Automated tally reporting
Budgeting and forecasting
Process optimization for finance
Financial data analytics
Reporting for business performance
This would be possible due to automatic reporting and better financial visibility enabling them to detect collection problems, cash needs, working capital movements and make proper growth decisions.
Conclusion
As can be seen from above, managing of the working capital involves more than just maintaining sufficient cash balances within the business. Growth oriented companies need to pay particular attention to such areas as fast collection of receivables, improved inventory management, reasonable terms with suppliers, cash flow forecasting and constant analysis of working capital ratios.
First of all, the working capital should have strategic importance for the business growth plan. With accurate and automated reporting, it would be easier for founders to see any existing problems.
For more details visit : https://budgetmaccha.com/
For enquiry: contact@budgetmaccha.com
