The working capital strategy you choose – and how fine-tuned it is to meet your business objectives – can have a major impact on overall operational success.
With an effective working capital strategy, companies are better placed to meet their short-term operating costs and debt obligations, achieve important business objectives, and fund expansion. So, what should companies bear in mind when creating their working capital management strategies?
Understanding working capital
Defined as the sum of a company’s current assets minus its current liabilities, working capital plays a crucial role in enabling companies to fund their day-to-day activities.
With insufficient working capital, businesses can struggle to maintain standard day-to-day operations. This can result in them failing to meet obligations as they fall due, which may result in lost supplier discounts and adversely affect credit ratings.
On the other hand, a strong working capital position can help companies achieve specific business objectives and invest in future growth.
Objectives of working capital management strategies
Companies can adopt different working capital management strategies depending on their business goals. Using conservative working capital management techniques, for example, a business can build resilience. With a more liberal, aggressive approach, it can focus on fueling growth.
- Build resilience: A conservative working capital management strategy is one that focuses on building operational resilience by holding higher levels of short-term assets. This might involve, for example, maintaining higher inventory levels (or safety stock) to absorb sudden increases in demand. Greater resilience can protect the business from the impact of seasonal downturns, challenging markets, or difficult economic conditions.
- Fuel growth: A more aggressive working capital management strategy revolves around making the maximum use of available capital to fuel faster growth. It might involve prioritizing things like speeding up the collection of receivables or paring back inventory levels. With an aggressive strategy, the business can maximize its working capital to fund expansion, invest in R&D, or harness M&A opportunities.
Six working capital management strategies
There are lots of moving parts in working capital management, which means there are countless ways of adapting one to suit specific business needs. These six strategies can help businesses manage their working capital more effectively, whatever their overall objective is.
1. Improve cash flow forecasting capabilities
Cash flow forecasting allows businesses to understand upcoming inflows and outflows in greater detail by collecting and analyzing data. It can, therefore, help them to make better spending decisions, maximize the efficiency of their working capital, and minimize cash flow risks. In other words, it’s essential for effective cash flow management.
Cash flow forecasting software can help by taking data from purchase orders, accounts receivable, and accounts payable to provide businesses with near-real-time cash flow forecasts that factor in all departments and business units. Cash forecasting solutions may also use machine learning and artificial intelligence (AI) to increase the accuracy of their predictions over time.
2. Refine your procurement strategy
Procurement represents one of the largest areas of expenditure for most businesses. By aligning their procurement strategy with broader business aims, businesses will be better placed to acquire goods and services of the right quality, at the best price, and in a timely manner. This is an essential component in strengthening control over working capital.
Individual procurement techniques can include tightening purchasing processes, streamlining the supplier base to benefit from bulk discounts, and renegotiating payment terms when awarding contracts.
3. Review inventory management strategy
Inventory is often cited as the working capital component that is most difficult for companies to improve upon. For example, businesses can mitigate the risk of supply chain disruption and stock outages by holding more inventory – but this also has the effect of tying up working capital.
Nevertheless, by adopting a suitable inventory management strategy, companies can improve their ability to keep close track of stock levels, minimize waste, and increase efficiency. Companies may also be able to use modern inventory solutions to reduce the impact of long in-transit lead times and gain access to nearby safety stocks.
4. Streamline the accounts payable process
By automating the accounts payable process, companies can achieve efficiency gains and thereby reduce costs. With more visibility over supplier invoices, companies may also be able to speed up approval times and capture early payment discounts.
Slowing down the accounts payable process is one way of boosting working capital – but this approach can also damage the relationship between the business and its suppliers. For businesses with low-value, high-volume accounts payable flows, another option is to use virtual cards to hold onto cash for longer while unlocking rebates.
5. Improve debt management
Poorly managed long or short-term debt can lead to costly outflows and may have a significant impact on available working capital. By seeking better interest rates or ensuring that debt payments are made on time, companies may be able to lessen the burden on the business and free up working capital.
Alternatively, companies may seek to improve their debt management by opting for cheaper short term financing solutions, such as working capital funding.
6. Make use of working capital funding solutions
Working capital funding solutions such as supply chain finance and accounts receivable financing can also significantly speed up cash flow:
- Supply chain finance is set up by the buyer and allows suppliers to receive early payment on their invoices, typically at a more favorable cost of funding. Since the buyer pays the funder on the invoice due date, both buyers and suppliers can benefit from improvements to their working capital position.
- Accounts receivable financing works as a line of credit backed by outstanding debt due to be received from customers. As such, it allows companies to free up cash trapped in their unpaid invoices, boost working capital, and make better use of their assets.
Building a working capital management strategy step-by-step
To capture the full opportunity that an effective working capital management strategy offers in terms of boosting financial health, it’s important to take a systematic approach to building yours. Get started with these four steps:
- Set your objectives: When creating a working capital management strategy, the first step is to decide on your objectives. These might include ensuring that the business has enough liquid assets to meet short-term obligations, including provision for unexpected costs. Additionally, your focus might be on growing the business or optimizing the use of capital.
- Review current strategy: If your company has an existing working capital strategy, this should be reviewed on a regular basis to ensure that it continues to align with the current needs of the business – whether your focus is on meeting current obligations or funding future growth.
- Find areas of improvement: By looking closely at all your working capital processes – including cash flow forecasting, procurement, inventory, accounts payable, debt, and working capital funding – you can identify areas where improvements can be made.
- Implement and further review: Having identified areas for improvement, the next step is to choose the working capital solutions most suitable for your business goals and industry. Once implemented, these should be reviewed on a regular basis to ensure that your working capital goals continue to be met.
