Working capital is typically expressed as:
Current Assets – Current Liabilities
So, in order to improve your business’s working capital position, you simply need to optimise your current assets relative to your current liabilities.
It’s not. And we’re going to prove it…
Working capital can be managed through 3 areas of business:
Accounts Receivables: Money owed to your business by customers
Accounts Payable: Money your businesses owes to suppliers
Inventory: The amount of raw materials, work in progress or finished products you have on hand
In this article, we’re going to give you some ideas on how you can optimise working capital in these areas…
1. Shorten Credit Terms
One of the easiest ways to optimise your working capital is to shorten credit terms and collect your accounts receivables as early as possible.
Obviously, the more generous your terms are, the more customers are likely to do business with you. But, if you’re experiencing late invoice payments, then shortening your credit terms is one of the surest ways to optimise your working capital.
You can also better enforce good payment behaviour by introducing incentives for early payments and penalties for late payments.
Requesting initial deposits will also help to reduce the total amount of money owed to your business.
2a. If you’re a large corporate organisation – use Reverse Factoring (Supply Chain Finance)
Reverse Factoring is utilized by thousands of large corporates globally. It works by arranging for banks or other finance companies to early pay your suppliers in return for them accepting a small discount on their invoices (that discount representing the cost of finance). You can then repay the financial institution on the invoice due date or at a later date mutually agreed with the funder.
2b. If you’re not a corporate — Utilise available supplier credit
Getting goods and services now and paying later is clearly a good strategy. This buy now, pay later arrangement can work in a number of ways. Three common strategies are:
a) getting your suppliers to agree to longer payment terms.
b) getting your suppliers to give you financing, as a way of facilitating the purchase of their goods or services.
c) Getting goods on consignment, where you pay for the goods purchased only if you sell them.
3. Optimise Procurement
Another idea for optimising working capital is to focus on optimising procurement. Key in procurement optimisation is the process of sourcing the best possible suppliers to work with your business.
Just how important are they?
Studies have shown that the 100 biggest U.S. manufacturers spend 48 cents of every dollar of sales to buy materials!
Finding the most reliable and best value suppliers can help you to price your products competitively and keep your inventory levels sustainable.
If you focus on building great relationships with suppliers you can trust, then you can be confident in your inventory management and therefore, by extension, your working capital management.
4. Supply Chain Analytics
The world of business is constantly moving forward. Prices change, customer expectations increase, technology advances. To stay on top, it’s important to keep up with the pace.
To optimise any aspect of your business, you need to collect and analyze data so that you can identify areas that need improvement — this is especially true of your supply chain.
Supply chains are one of the primary drivers in a company’s cost structure and profitability. And, a well-oiled supply chain can improve overall business performance, especially working capital.
5. Partner with a Finance Company
Financial engineering can un-lock enormous opportunities to improve your financials, with little or no investment. Both commercial banks and specialist financiers support their clients with a variety of creative finance strategies, tailored to meet specific company needs — from simple loan facilities, to structured financial instruments.
Opportunities for optimising working capital are only limited by your creativity. Hopefully the above examples will provide some starting points for your thinking. And, by contacting parties providing services in the example areas, you can leverage their expertise to help shape your working capital optimisation strategy.
For the facts and figures on working capital, take a look out our new infographic: