What is working capital management and why is working capital management important to your business?
In its most basic form, working capital is the cash available to a business to pay its day-to-day operating expenses, such as salaries and raw materials.
Yet with businesses still finding it difficult to gain access to finance, managing working capital has become more important than ever before.
Effective management will mean working at both ends of the equation, by managing the cash coming in as well as the cash going out. Below are some of our tips to achieve this.
Managing your customers
A business can improve the incoming cash side of their working capital by reducing the time customers take to pay. This can be achieved by thinking about the following:
- Reducing the level of credit being offered to customers
- Offering early settlement discounts
- Ensuring there are effective credit control procedures in place to chase any slow paying customers
- Introducing a factoring or invoice discounting facility if appropriate. This has been demonstrated as one of the best ways of funding the working capital requirements of a growing business
Managing your suppliers
It’s also vital to focus on the outgoing cash, and it’s worth considering the following:
- Take the maximum available credit period on offer from suppliers
- If suppliers are unable to offer credit, you should identify the reasons why and look at improving their rating so that suppliers will offer credit
- You should talk to your bank or professional advisors if there are better ways of funding your purchasing through trade finance (such as letters of credit)
Managing your business
Having a clear idea of the working capital requirements within your business will make management much easier.
Once the requirements have been determined, it’s vital that you and your management team identify the most effective way of funding the working capital.
It is, however, a constantly evolving issue and what’s right for your business today may not be the best solution tomorrow. The overdraft that has supported the business for your first few years may not be the right solution to fund your growth or expansion and some of the options outlined above may become more appropriate.
Therefore, businesses should regularly discuss their working capital requirements with their professional advisors and bankers. This will ensure that the facilities available moving forward are able to meet your forecast requirements.
Additionally, business owners should not neglect the more obvious ways of managing working capital by reducing the cash requirements within the business.
For example, keeping as many overheads as variable as possible, managing stock holding to ensure that cash is not tied up in slow moving stock, or simply looking at reducing the monthly outgoings can all help.
Over the years we’ve seen many very profitable businesses fail simply because they had not effectively managed their working capital. In this challenging economic environment, the only way a business can grow and continue to exist if it is has the cash to pay its bills.
Maybe the new year is a good time to start paying better attention to your working capital. Good luck!
Bobby Lane is a partner at chartered accountancy firm Shelley Stock Hutter LLP.
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