Having enough working capital can make or break your small business. How you manage working capital directly impacts your operational cash flow and your profits as well.
Net Working Capital is very useful as it provides a simple indicator for the business’ abilities to meet its short-term cash obligations. It is calculated roughly by finding the difference between current assets (assets that can be turned to cash in less than a year) and current liabilities (liabilities that must be paid in less than a year). Understanding this equation is fundamental to controlling your working capital.
In this post, we’ll outline some tips and tricks for smart working capital management, so you don’t need a PhD in economics to improve your cash flow.
Forecast Demand and Manage Inventory
Maintaining a large inventory can tie up a significant portion of your working capital. Having a larger inventory increases your current assets, but it can also become a liability if you don’t sell right away, resulting in storage costs or, worst-case scenario, you don’t manage to sell the inventory at all. Accurately forecasting demand enables you to provide just enough inventory as is needed without tying up your working capital. Check out our blog on overage vs. underage costs to learn more about optimizing your inventory costs by simple forecasting.
Additionally, there are many tools you can use to improve your forecast accuracy including Logility, Blue Ridge, and Terra Technology. Another great way to reduce your working capital is to sell “dead” inventory, even at considerable discount. This may seem unwise at first, but this can cost less than the alternatives (paying for storage, etc.), and will free up some cash.
Reassess Invoicing and Payment
The best way to ensure you have working capital is to make sure money is coming in on time, or early. One of the most important aspects of managing your working capital is to send out invoices as soon as possible (unpaid invoices increase your current assets). Bill customers promptly and reconsider how long you can wait for payment. Whereas traditionally, the payment period was 30 days, it is now becoming more acceptable to ask for payment within 15 days.
On the opposite side of the transaction, try to negotiate more favorable payment terms with vendors that provide services to your business. The overall goal is to accelerate money coming into the business while delaying the funds going out. In other words – it ensures that the current assets and current liabilities grow together, so your overall working capital doesn’t grow. You can read more about this in Small Business Cash Flow: Managing Financials.
Always Look Forward
Strategic planning is crucial to maintaining your working capital. You need to carefully plan and assess your capital needs in the next week, month, quarter, year, or more. Will you have to upgrade your software? Provide employee training? Move to a larger office space? There is no end to considerations, not to mention surprise expenses that have a habit of popping up. Plan accordingly and set aside funds for future projects or a rainy day.
Proper working capital management takes both time and effort, but it is critical if you want your small business to grow and take advantage of new opportunities.