The effective management of working capital can mean the difference between success or failure for a business – and particularly for entrepreneurial start-ups and SMEs in highly competitive sectors. But how exactly does one define working capital – and how can it be managed to best advantage?
Put simply, working capital is the difference between a business’s short-term assets and short-term liabilities – or in other words between everything it owns and everything it owes. In effect, it represents the amount of cash the business has to fund its day-to-day operations and power its growth.
So how exactly can you control your working capital management to give your business the edge?
Make working capital management everybody’s business
The first issue is to think holistically: maintaining working capital should be everybody’s business and not just the remit of the credit control team. By implementing clearly understood KPIs on working capital management, backed by individually tailored training, you can ensure that everyone is focused on financial matters and continuous improvement.
Although it may seem counterintuitive, paying suppliers on time can help a business’s working capital. As part of your working capital management, suppliers who are paid on time and who do not need to chase up their invoices are far more likely to offer flexibility in negotiations and demonstrate loyalty to your business. More broadly, effective negotiation is central to success, and you can give yourself the edge by assigning each supplier a named contact who builds up a strong, friendly and resilient working relationship.
Control expenses carefully
Over a period of time or a large number of employees, even small expense claims can mount up. The trick is to set clearly understood rules for travel and accommodation and make sure that your team adheres to them, whilst carefully controlling the cost of compliance. Corporate card programmes can make expenses more visible, allowing management to take an overview of any excesses and deal with any areas of non-compliance or any employees abusing the rules.
Keep an eye on your stock
Holding unnecessary levels of stock can be a huge drain on working capital, and these issues frequently result from poor communication between departments. Working capital management through the use of monthly or quarterly stock checks will highlight any discrepancies, but it’s essential that you act quickly on your findings. Of course, effective inventory management also aims to eliminate stock shortages, so it’s something of a balancing act, involving careful assessment of each and every product line.
Also on the subject of stock, e-procurement has reduced costs substantially for many businesses. Indeed, e-procurement specialists Wax Digital confirmed savings of 18% resulting from e-auctions and from comparing different suppliers’ terms and opting for those with longer payment times. E-procurement also necessitates a rigorous authorisation process, which can help to reduce unexpected spending and protect your working capital.
But if you’re focusing on all the above approaches yet still experiencing shortfalls in your working capital, what are the best approaches to take with your working capital management?
Alternative lenders can make all the difference
Whilst bank overdrafts can overcome short-term difficulties, they traditionally attract high rates of interest. In order to get your working capital management on track your business may be able to secure far more advantageous terms from an alternative lender, who can offer you a choice between emergency business loans, asset-based finance and invoice factoring and discounting. But it is important to understand how to make business finance work for you.
As their name suggests, emergency loans aim to address sudden shortfalls in capital, and the finance can be in your account in as little as 24 hours. Alternatively, for a longer-term solution asset-based finance enables you to borrow against the value of your premises, plant or equipment. Because the lending is secured, the interest rates will be considerably lower and you may be able to repay the loan over a much longer period. In many cases, finance providers will fund emergency loans directly whilst using a panel of lenders for asset-based finance – this element of competition reduces interest rates whilst addressing the problem of particular lenders being reluctant to invest in particular business areas
Introducing invoice factoring and discounting
Another very effective solution to working capital management issues is invoice finance. This flexible finance option allows you to borrow up to 85% of the amount of your outstanding invoices, the very moment you issue them. The loan, interest and fees will then be repaid when your client pays and you will receive the balance.
With invoice discounting, you maintain control of your own ledger, whereas with factoring the finance company takes ownership of the debtor book and assigns credit control professionals to secure early payment. As a result, factoring tends to produce faster payments and hence less interest to pay, though there are fees for the factoring company’s expertise. However, some businesses prefer to keep control of their own debts so that their clients do not find themselves dealing with a third party.
Carl is a business recovery specialist and as Managing Director of Cashsolv he offers advice and support to overcome cash flow problems and identify possible underlying problems that can be addressed to ensure a positive future for your business.