How to improve working capital
/Working capital is the excess of a firm’s current assets over its current liabilities. It represents a major cash flow concern for many companies, which are continually in need of additional working capital financing. How can the working capital situation be improved? Consider the following possibilities.
Investigate Customer Credit
Working capital improvement starts at the point when a prospective customer applies for credit. You should investigate all credit requests of any size in detail, so that only creditworthy customers are granted credit. This can involve a review of an applicant’s credit report, calling its trade references, and examining its financial statements.
Issue Invoices Faster
Customers will not pay if they are not billed. Therefore, collect the shipping documents and customer purchase orders associated with each delivery, and issue an invoice as soon as possible. For large invoices, consider sending the document by overnight mail (despite the cost) in order to accelerate customer payment even more. Another option is to issue electronic invoices, with an integrated ability for the recipients to pay these invoices on the spot, either with a credit card or a bank transfer.
Related AccountingTools Courses
Speed Up Cash Collection
Have customers send their payments to a bank lockbox, which can accelerate the flow of cash by a day or two. Otherwise, check payments may spend excess time on the company premises while they are logged into the cash receipts system. In addition, start collection activities as soon as invoice due dates have been reached - do not give customers a buffer. This more aggressive stance tells customers that they cannot stretch payments past the terms to which they have agreed.
Delay Supplier Payments
Discuss with suppliers the possibility of being granted longer payment terms. This is more of a possibility if you are doing a large amount of business with these suppliers. If they are not interested, then consider switching to new suppliers who are more flexible about granting longer payment terms.
Accelerate Inventory Turnover
Buy inventory in smaller quantities, so that the company is maintaining a smaller inventory stockpile. This may involve more supplier deliveries to the company, as well as somewhat higher costs (since the firm may not qualify for volume discounts). Nonetheless, accelerating inventory turnover can result in a significant decline in working capital. An added side benefit is that, with less inventory on hand, the company will probably experience a decline in its losses from obsolete inventory. Further, if the firm already had too much inventory on hand, then send it back to suppliers (probably in exchange for a restocking fee) or sell it off to third parties.
Outsource Operations
Outsourcing selected operations to third parties means that the company does not need to invest in the assets associated with those operations. One of the best places in which to consider this is manufacturing, since some production operations require a massive investment in fixed assets. However, outsourcing can eliminate valuable resources that the company might need if management later decides to bring outsourced functions back in-house.
Lease Assets
Consider leasing assets rather than purchasing them. Doing so keeps the company from having to make a large out-of-pocket purchase up front. Instead, it makes a series of predictable payments over the life of the lease, along with a built-in interest charge. The main risk here is to not be locked into a lease for too long, since lease agreements can be difficult to terminate before their scheduled completion dates. Also, examine the costs associated with a lease before signing the deal, since some of these fees can be quite expensive.
Sell Off Assets
Review the assets being used by the company (including real estate) and see if any of them can be sold off for cash. Doing so not only brings in additional cash, but also eliminates any expenses associated with them. For example, unused real estate still incurs ongoing property taxes. However, do not sell assets that are part of the production capacity of the business, and which you might need when demand spikes.