Working capital is an integral metric for assessing the long-term financial health of your business, no matter what your company size or industry. However, figuring out a well-founded strategy for working capital management can be perplexing, as most business owners aren’t financial experts. Nonetheless, it must be a top priority.
Not only does effective working capital management ensure your company maintains adequate cash flow to meet your short-term debt obligations and operating costs, but it also helps to improve your company’s profitability and smooth your financial operations. Take a look at our top four tips on working capital management.
1. Collect AR Within Terms
This is money your customers owe you; you’ve already earned it. The best guarantee for having working capital is to make sure money is coming in on time. Therefore, send invoices as soon as possible so there’s no gap in payment. This, of course, requires having a sound collections system in place.
Assess your invoicing processes to eliminate any inefficiencies that may be causing delays in sending invoices to your debtors (manual processing, lost invoices, high volume of invoices to manage, etc.). If you don’t already, consider using technology to deliver invoices electronically to speed up billing and collection, and ultimately shorten your cash conversion cycle. Automating allows you to track inflows and outflows with ease. You may also want to send reminders mid-stream to alert your customers that their payment is nearly due.
2. Structure contracts to have your customers pay you upfront
The biggest, most obvious advantage to having customers pay upfront for goods and services is that it provides you more cash to work with. If you’re a startup, this can be an enormous advantage. You can then reinvest the cash into your company to fuel and accelerate your revenue growth. For instance, you may hire additional sales reps or pour the money into R&D to improve your products. Be careful to allocate your resources strategically and prudently.
As you assess your contracts, make sure your language clearly spells out the terms of payment. And realize that getting customers to commit to upfront payments may not be an easy task. You may find yourself in the position of giving a discount to convince customers to pay upfront. It’s up to you to figure out the right balance and decide if a discount is worth having that cash in hand.
3. Don’t over-invest in inventory
Companies often make the mistake of overstocking inventory, which leads to finished goods sitting in the warehouse for too long. Think of inventory as tied-up cash and aim to sell finished goods as soon as possible. Cut products and services that aren’t performing, as stockpiles do your company little good. It’s essential that you strike an operational balance. Aim for continuous production with minimal investment in raw materials and minimal reordering expenses.
4. Negotiate payment to vendors for as long as possible
Negotiating payment terms with vendors allows you to maximize your cash flow. Try to defer partial payment later, which gives you more working capital to pay expenses and salaries, or invest the money back into your business. For example, if you and your vendor agree on payment terms of 30/70 and deferring 70% of the balance until after production, you have another 30-45 days to make that money work for you.
Additionally, negotiating payment terms gives you leverage over your vendors should you encounter quality issues. You take a far greater risk when you pay 100% in advance. It’s wiser to err on the side of caution, particularly when dealing with new vendors. What if something goes wrong in production, the supplier disagrees, and you’ve already paid in full? Or, worse, what if your supplier suddenly closes shop and doesn’t respond? The chances you’d get your money back are slim. As a company, it’s important to focus on continuously improving your working capital position. Your commitment will go a long way in contributing to the growth of your business.
If you’d like to discuss how we can help set up your company for long-term financial success and operational efficiency, please contact us so we can get the ball rolling.
Have further questions about working capital management? Drop us a line by filling out the contact form below. G-Squared provides strategic financial, accounting, and operational expertise to CEOs and entrepreneurs in Philadelphia, New York City, and Washington D.C.