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Four tips on optimizing your working capital

You can’t run a marathon if you haven’t eaten in two days. This truth holds no matter how much extra weight or so-called “energy reserves” you might be bringing along. The reason? When running, your body relies on its short-term existing energy supplies rather than the long term stockpiles that might be stored as fat.

In the same way, your business needs working capital in order to carry out its daily processes. Your working capital could be viewed as the meal before the marathon – it’s the cash you need to finance your operational needs. In accounting terms, your working capital is your current assets minus your current liabilities.

Pre-race nutrition requires one to strike a delicate balance. Too much food will weigh you down and tire you out. Your body will be required to spend some of its energy on digesting the meal rather than running the race. Too little food (or food of the wrong kind) can leave you exhausted and dehydrated. In the same way, an optimal balance must be struck when managing your working capital. Having too much cash or an oversupply of assets in the business means the money could have been used better elsewhere – earning interest as an investment or ploughed into a new project. Too little cash could have the spiral effect of leaving bills and salaries unpaid.

Here are four quick tips to help ensure your working capital equates to the optimally balanced meal required to run the “race” your business faces.

 1.    Negotiate discounts and/or longer payment terms with your suppliers.

It is imperative that you have a strategically minded, skilled negotiator on board to strike agreements with your key merchants and service providers. The onus is on your company to convince your suppliers that their relationship with you is strategic to their success. Striking a discount with a supplier is their acknowledgement of your company’s importance to their business. Help them realize that they need you – and why. In addition, there is nothing wrong with taking more than 30 days to pay a supplier if this has been outlined to in the service level agreement.  Negotiate hard, and then refer to point two.

 2.    Pay your suppliers on time – no exceptions.

It’s not unusual for startup businesses to get caught in a cat-and-mouse type scenario when it comes to meeting obligations to suppliers. Companies will tell themselves: “If we can delay paying company B for a certain amount of time, we will have enough money to do X”. However, that type of thinking is inherently risky and often engenders a vicious cycle. The longer you delay paying your suppliers, the longer it extends the payment cycle. Additionally, your company becomes liable for interest after a certain period of time, and your company’s reputation for being a bad payer could cost you key relationships and jeopardize your ability to negotiate favourable rates. Paying your suppliers on time means that you will have a dependable amount of working capital at any given moment. If you pay erratically, your working capital will see similar fluctuations, making it difficult to plan.

 3.    Manage your stock actively.

Your working capital consists not only of cash on hand but primarily of stock / inventory. Many companies do not keep an accurate account of their working capital by failing to keep abreast of their inventory. Ensure you have a good idea of what stock you have on the floor, reflecting on the fact that this can theoretically be converted into cash at a given rate. Don’t always accept your stock manager’s value of what the provision for obsolescence should be. He will always under estimate the provision to protect himself from negative inferences. Once in a while get an independent valuation expert in to determine this figure. Rather this than a rude awakening when you need it least.

4.    Make expenses more visible.

As a business owner, it is easy to let bad habits creep in when it comes to meeting ad hoc costs for your company. For example, you might purchase stationery with your personal credit card, or pay a once-off supplier from your own bank account. However, this makes the tracking and prediction of working capital more difficult. Try to be rigorous about ensuring that expenses are flagged and processed following the outlined protocol – no matter how small. The result will be that cash on hand will be more traceable and predictable, and your working capital will be optimized.

If your company needs assistance in formalizing cost processes, managing stock or establishing the right level of working capital, The Finance Team could have a solution. We have a network of highly qualified and experienced finance professionals who are available to assist your company on an ad-hoc or interim basis.

Image credit: thekickasslife.com

 

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