4 Tips for Effective Working Capital Management

Author: Sean Mills, President, Commercial Loan Officer 02/18/2021

Effective working capital management is a mark of a good business, but growing businesses and high sales will strain cash flow and offset the balance of working capital. It’s a paradoxical challenge that a growing business causes increased expenses and a lack of working capital while cash is needed the most.

The following working capital management best practices will help your business to better run operations, pay employees, and secure financing.

Reduce inventory and increase inventory turnover

Well-managed inventory management may be the most powerful leverage to working capital improvements. Achieving a higher net working capital calculation can be achieved by reducing slow-moving inventory, increasing the inventory turnover cycles, and avoiding stockpiling. Although inventory is considered an asset in the working capital formula, less inventory on the shelves equates to more freed up cash flow.

Enabling cash efficient production and operation techniques can be achieved by pull inventory methods such as the just-in-time strategic method of inventory management. Applying these methods as well as utilizing inventory automation systems or e-procurement can greatly reduce costs and boost capital through hyper-efficient inventory management systems.

Utilizing the inventory turnover ratio or days inventory outstanding (DIO) metrics that reveal the average number of days a company holds its inventory before selling it will allow a company to better understand its inventory turnover. An analytical working capital management team will periodically measure turnover rates, compare it to industry competitors, and uncover opportunities to reduce their DIO that result in increased savings and working capital. Efficient inventory management can have a significant impact on accounts receivables, accounts payables, operations, and overall profitability and growth.

Pay vendors on time and manage debtors effectively

Enforcing payment discipline should be a key part of your payables process. Analysis of working capital levels shows that the biggest improvement comes from improved payables performance and reduced days payable outstanding (DPO).

The best way to ensure you have enough working capital available is to make sure money is coming in on time. Reassessing your contracts and credit terms with debtors may be necessary to make sure you are not giving debtors too big a window to pay for goods and services, as this may be impacting negatively on your own company’s cash flow. CFOs should review credit terms with company management to ensure that the level of credit being offered to debtors is appropriate for your company’s cash flow needs. To reduce bad debts, you should implement more rigorous credit checks and ensure that effective credit control procedures are in place for chasing late-paying customers.

Convert to electronic payables and receivables

In order to shorten the receivables period, organizations need to have a good collections system in place. One important aspect of working capital is to send out invoices as soon as possible. Companies should reassess invoicing processes in order to eliminate inefficiencies that may be causing delays in sending invoices to your debtors. Such inefficiencies may include manual processing, lost invoices, and high volume of invoices to manage.

The conversion from paper to electronic transactions has transformed payment processes. Electronic payments are a well-known trend, but optimizing payables and receivables with automated processes is imperative to cash efficiency and accelerated cash conversion cycles. Electronic payables processes such as purchasing cards can offer working capital increases in a company’s accounts payables. Automated payments and electronic payment processes can open the door to favorable capital conserving payment terms, savings on rebate structures, and significant cost reductions.

Utilizing accounts receivables technology to deliver invoices electronically can also potentially shorten the receivables period and the CCC. Electronic receivables will reduce manual processing, error, lost invoices, and will ensure proper management with reminders eliminating some timely inefficiencies.

Receive adequate financing

Receiving working capital financing to increase working capabilities is achieved by possessing enough liquidity to finance current operations without taking on excessive risk. By analyzing working capital KPI’s and determining working capital needs can direct a business to carefully selecting the right financing solution and adequate fund size for forecasted operational needs.

In addition to short-term business loans, a business may instead opt for financing fixed assets with a long-term loan to stabilize healthy cash flow. Using existing cash flow to pay suppliers or fulfill purchase orders can potentially earn strong relationships, secure discounts, and increase cash return on asset investments counteracting the paid interest.

Grow your business with well-managed working capital

Working capital management improvements can generate more cash for a business, increase operational efficiency, and raise profitability and potential growth. To learn more about how PlainsCapital Bank can improve your payables and receivables processes or provide working capital financing, speak with a PlainsCapital Bank representative today at 866.303.0557.

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