Worried About Running Short on Cash? Making Working Capital Work

Never underestimate the power of efficiently managing working capital. It‟s one of the basic “blocking and tackling” functions in an accounting role. Improving the management of working capital will not only enhance your company‟s return, but also lower your risk of running out of cash. Below are some actions you can take to better manage working capital, as well as some metrics you can implement to measure performance.

What You Have to Work With

While the calculation for working capital is current assets less current liabilities, it‟s literally the money you have to work with and a measure of your company‟s short-term financial health. For the most part, working capital includes cash, accounts receivable, accounts payable and inventory. Let‟s take a closer look at each and some tips for better managing them.

Receivables, Payables and Inventory: Ways to Keep the Cash Flowing

Get What‟s Coming to You: Accounts Receivable (AR) –This is the amount due from customers in exchange for goods or services that have been delivered or used, but not yet paid for. Turning receivables into cash as fast as possible will improve your cash flow. Below are some specific measures you can implement to better manage AR:

1. Bill customers as soon as possible. Every day you delay billing is one more day you are not collecting cash.

2. Set up recurring credit card payments or electronic receipt of payment. While there is a cost associated with credit card payments, there is also a cash flow benefit. You‟re also reducing costs by not sending out a bill. It‟s an option whose cost/benefit is worth evaluating.

3. Establish a collection policy. Set up an internal process to manage and follow up on collections. Work with a collection agency or attorney to follow up on delinquent accounts.

4. Charge interest on late payments. Include a provision in your customer contracts to charge interest for late payments.

5. Follow up on late accounts with a series of letters. Also, follow through on any actions you say you will take if a customer does not pay.

IOUs: Accounts Payable (AP) – This is the amount owed to your vendors for goods or services rendered. While your accounts must be paid to be considered in good standing with creditors, paying your vendors as late as possible without incurring finance charges keeps cash on hand, improving cash flow. Here are some things you can do:

1. Delay payments to vendors without paying interest. Extend payment to those that do not have interest terms.

2. During periods of significant growth, talk to strategic vendors about longer payment terms. A strategic or exclusive vendor might be inclined to provide longer terms or even a short term loan during a period of significant growth. It doesn‟t hurt to ask!

3. Renegotiate longer terms for more business or exclusivity. As your company grows, you become more significant to your vendors. Vendors that benefit from increased business as a result of your company‟s growth may be willing to help out with longer terms.

Striking a Balance: Inventory – This is the product on your shelf for sale to customers and it represents a potential source of revenue. But, it is not like money in the bank,” as one of my clients once told me! The costs of inventory
also include the space needed to house the product. Carrying too much or too little inventory can hurt your business.

Below are some ideas on how to improve inventory management:

1. Buy inventory on a consignment basis. The inventory is not owned by you and you won‟t pay for it until you actually use it.

2. Utilize „Just in Time‟ inventory methods when feasible. Order what you need, when you need it, minimizing inventory costs.

3. Analyze inventory into fast and slow moving categories. Set up different reorder points based on how quickly the inventory turns.

4. Take advantage of returning obsolete or aging inventory to the vendor. Some vendor arrangements will buy back inventory up to a certain period of time.

Measuring and Managing

Finally, benchmark your working capital metrics over time and compare to others in your same industry. Pay special attention to the metrics that reflect how efficiently working capital is being managed:
Accounts Receivable Days: This number reflects the average length of time between credit sales and payment receipts and is crucial to maintaining positive liquidity. Its calculation is:

(Total AR ÷ Sales) x 365

Accounts Payable Days: This ratio shows the average number of days that lapse between the purchase of material and labor, and payment for them. It is a rough measure of how timely a company is at meeting payment obligations.
Its calculation is:

(Total AP ÷ COGS) x 365

Inventory Days: This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Its calculation is:

(Total Inventory ÷ COGS) x 365

Once you’ve developed metrics, be certain to share them with your accounting and management teams so that everyone is measuring and tracking performance in the same way. By focusing on the basics, you should be able to make your working capital really work for your business.