Working capital—the measurement of a company’s liquidity and ability to cover its day-to-day operations—is fundamental to all businesses. When you subtract your firm’s current debts from its liquid assets and liabilities, the number that remains is your working capital. Ideally, your company should have enough working capital to meet its obligations, plus some left over to cushion against unforeseen circumstances. For example, the COVID-19 pandemic generated a crisis for many U.S. companies. Its government-mandated closures could only be weathered by organizations with carefully managed working capital reserves. So, how do you manage working capital to ensure you’re prepared for the unexpected? Continue reading for suggestions.
Tips for Managing Your Working Capital
Positive working capital enables your company to increase profits and establish efficiency in its operations. Effective capital management is crucial in ensuring sufficient cash flow to meet short-term obligations, thereby supporting financial stability and profitability. It also improves its potential liquidity, which can be useful in times of distress and during periods of growth. Conversely, having too much working capital may also indicate trouble. Allowing assets to sit idle, rather than investing them in expansion efforts and upgrades, is an inefficient use of your resources. It could be viewed as indicative of missed business opportunities and poor financial management. The following tips can help you find the proper working capital balance for your company:
Establish Strong Vendor Relationships
Many small business owners overlook their vendor or supplier relationships when looking for ways to increase working capital. However, ensuring your contractual and financial obligations are met promptly can help you optimize your firm’s cash flow. Companies that have fewer outstanding accounts payable purchase orders can foster better vendor and supplier relationships. When it’s time to renegotiate, you can leverage your positive relationships to secure better deals, improve payment terms, and garner discounts. Demonstrating goodwill and keeping your vendors and suppliers happy will help you improve your working capital reserves over the long term.
Monitor Your Inventory
Inventory is a current asset used in calculating your working capital. Effective inventory management plays a crucial role in working capital management by improving cash flow, minimizing costs related to excess stock, and enhancing overall resource efficiency. When you purchase merchandise, the goal is to maintain enough to satisfy demand while avoiding excessive inventory. If you don’t keep enough inventory, you run the risk of alienating potential customers and losing sales to your competitors. However, when you are overstocked, you might incur unnecessary costs for storage, insurance, and unsold or expired inventory that you cannot liquidate for a profit. This can tie up substantial amounts of working capital. Analyze your sales and purchases to find the optimum inventory balance. Perform monthly or quarterly inventory checks so you can make adjustments as needed when trends shift or suppliers change.
Create an Effective Accounts Receivable Procedure
Customer payments are the lifeblood of your business and a vital component to managing your working capital. Efficient cash flow management is crucial for maintaining financial stability and operational efficiency. If you run an invoice-based operation, collection delays can impede cash flow, which, in turn, reduces working capital. To avoid this scenario, take action to improve your accounts receivable (AR) process. For example, you should:
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Send out invoices promptly—The sooner your customers get their bills, the faster you will get your payments.
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Ensure all invoices are error-free—Any invoicing mistakes will result in the additional time and expense of revising and resending. You can preserve more of your working capital by doing it right the first time.
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Deliver invoices electronically—Save the time and cost involved with mailing paper invoices by delivering them through email.
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Maintain accurate and detailed records—Be diligent about tracking payments and balances for each of your accounts to save time and money in the long run.
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Employ automation whenever possible—Automated systems can save you time by creating and distributing invoices, sending payment reminders to owners of delinquent accounts, and compiling accurate records.
Take Steps to Reduce Bad Debt and Improve Cash Flow
Even with the most efficient collections procedures, you will likely encounter debtors who do not pay on time. Effective working capital management is crucial in optimizing cash flow and preventing defaults on debts. These may be customers with outstanding invoices or partner companies to whom you’ve extended credit. To avoid and minimize the effects bad debt has on your bottom line:
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Screen potential debtors—Before extending credit to anyone, take the time to run their credit report and check their references. You will then have the data you need to decide whether to offer credit and at what terms.
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Regularly evaluate your AR terms—You should customize terms for each debtor to minimize your company’s risk. For example, you could choose to require cash payments or establish a late fee for those more likely to default.
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Track down late payments—Establish procedures for how you will handle late payments. In addition to sending reminders and charging late fees, you may want to consider when and how you will forward accounts to collections.
A Working Capital Shortage
Sometimes, despite everything you do to manage working capital and get your business on a profitable path, your revenue still comes up short and fails to cover your expenses. Net working capital, which evaluates a company’s liquidity by subtracting current liabilities from current assets, plays a crucial role in understanding your financial health and ability to meet short-term obligations. Maybe you own a company that earns the bulk of its annual revenue during particular seasons. Without careful budgeting to preserve working capital, you’ll likely run short on funds during the slow months.
Or your business has an expansion opportunity, but you can’t get funding due to poor credit. What can you do to solve your short-term cash flow crisis?
How Finance Logix Can Help
Finance Logix is financial solution that’s not a credit or debit card. It can support your company with access to short-term working capital when traditional lenders can’t. Maintaining your company’s financial health is crucial for ensuring liquidity and meeting short-term obligations. Our underwriters utilize an automated system to analyze your bank activity, allowing us to approve your application within minutes. Once you receive your card number, you can use it to pay for any business expense up to your maximum spending limit. Use your Finance Logix account to:
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Maintain vendor relationships by using the funds to meet payment deadlines
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Purchase inventory so you don’t lose customers due to out-of-stock items
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Invest in technology to automate tasks and improve your accounts receivable processes
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Cover all of your business-related expenses
To find out if your business is eligible for this one-of-a-kind financing opportunity, reach out to a Finance Logix customer service representative. Call +1-877-662-3489 or fill out our online contact form to start managing your working capital today.
