7 Practical Strategies for Effective Working Capital Management

September 24, 2024

What is  ‘working capital’ ? And how do leaders effectively manage it?

This refers to managing the company’s  short-term assets and liabilities , so the business has the  liquidity  to meet short-term obligations and fund its day-to-day operations. 

Here are some  practical strategies  to strengthen a business through astute working capital management. 

1.  Get to Know Your Working Capital Ratio

The  Working Capital Ratio  (or current assets divided by current liabilities) gives a good indication of the liquidity position. A ratio above 1 indicates enough assets to cover short-term liabilities.

For example, a manufacturing business may  set a target ratio of 1.5 or  higher.  If below that level, corrective action is considered, like adjusting inventory levels or renegotiating supplier payment terms.

2.  Understand the Impact of Inventory Levels

Excess inventory ties up cash. Minimise ‘carrying costs’ while ensuring there’s stock to meet customer demand.

For example, a retail chain  uses inventory management systems  to track sales data in real time. Understanding sales patterns and adjusting inventory accordingly, reduces excess inventory which can greatly improve cash flow.

3.  Renegotiate Payment Terms with Suppliers

Some suppliers will agree to more favorable payment terms or even discounts to retain your business. Extending payment terms gives more time to pay bills and improves cash flow.

For example, a construction company  extended payment terms with its main supplier,  resulting in improved cash flow and the ability to fund immediate projects to completion.

4.  Encourage (or Incentivise) Early Payment by Customers

Ensure customers pay promptly and consider incentives for early payments, including discounts. Invoices must be sent on time so customers have no excuses!

For example, a marketing agency  implemented an automated invoicing system  that sends invoices immediately after projects are completed. The average collection period became 30% faster, improving cash flow and reducing bad debt.

5.  Manage Accounts Payable

Delay payments to suppliers without harming relationships. Be aware of late payment penalties that could offset any benefits.

For example,  A technology company takes advantage of  grace periods offered to loyal customers by certain suppliers  resulting in improved working capital without disruptions to its supply chain.

6.  Utilise Accurate Cash Forecasts

Cash flow forecasts help predict cash needs and shortfalls, so they can be addressed well in advance.

For example, a restaurant chain  forecasts cash on a quarterly basis.  Seasonal shortfalls are identified and managed by adjusting marketing and labor expenses.

7.  Consider Financing Options

Credit or short-term loans increase working capital, used to cover short-term obligations or growth.

For example, a retailer experienced delayed customer payments.  Securing a line of credit  enabled quick access to funds for immediate financial obligations and to maintain smooth operations.

Use these strategies to improve the understanding and management of business working capital, ensuring the liquidity needed to operate efficiently and grow.

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