5 Ways to Increase Working Capital
May 16, 2024
At a glance:
- The main takeaway: Cash planning ensures sufficient cash flow to support growth initiatives and financial obligations. Develop a weekly cadence around a 13-week Cash Forecasting Model for visibility into short-term cash needs.
- The impact on your business: Evaluate how long it takes to collect customer payments and pay vendors. Find ways to speed up collections and extend payment terms.
- Next steps: Leverage debt facilities such as a line of credit or short-term loans to cover cash flow gaps.
The full story:
Enhancing working capital is pivotal for bolstering any business’s financial robustness and long-term viability. Efficient cash flow management and working capital ensure smooth operations and empower you to capitalize on opportunities while navigating economic fluctuations. Mastering these financial practices can help you navigate economic uncertainty, seize opportunities, and maintain a strong financial foundation for the company.
Working capital is the money a company uses to fulfill its financial obligations. It is a financial metric that represents operating liquidity available to businesses. Working capital is part of operating capital, along with fixed assets such as plant and equipment. Working capital is calculated as current assets minus current liabilities. If current assets are less than current liabilities, your company has a working capital deficit or negative working capital. The Working Capital Ratio is calculated by dividing current assets by current liabilities. A ratio of less than one indicates potential future liquidity problems, while a ratio of 1.5 to two indicates solid financial ground in terms of liquidity. Current assets and current liabilities typically include four accounts in which managers have the most impact – cash, accounts receivable, inventory, and accounts payable. Improving working capital involves managing your company’s current assets and liabilities more efficiently to ensure that you have enough liquidity to meet short-term obligations.
Your business may require additional working capital for a few reasons.
- Seasonal cash flow is needed to support the need for extra capital during the busy season or to continue operations during the slower months.
- Fund obligations to subcontractors, suppliers, employees, and the government while waiting for customer payments.
- Support the addition of new contract awards.
- Inorganic growth opportunities.
- Internal R&D projects.
- Expansion of service offerings or locations.
Here are five strategies to improve working capital.
I. Shorten Operating Cycles
Improving cash flow is essential for enhancing working capital, and this can be achieved by shortening the operating cycle to convert tied-up funds into cash quickly. Enhancing the cycle reduces the risk of non-payment and has a significant impact on working capital. To achieve this, companies can adopt strategies such as offering early payment discounts, tightening credit policies, following up promptly on late payments, requesting upfront payments, minimizing credit terms, billing immediately post-sale, and adopting automated invoicing to streamline processes and improve cash flow efficiency.
II. Slow Accounts Payable Outflows
Working capital can be improved by slowing down the release of accounts payable to creditors and suppliers with extended payment terms while complying with the FAR. This can also be achieved with process improvement. With automation, your business can improve its visibility of outstanding bills. Lastly, virtual cards can maximize payment windows; suppliers receive payment immediately while you pay later based on the defined payment terms.
III. Inventory Management
Leaner approaches to inventory management that shorten the cash conversation cycle and preserve cash can maximize working capital. Reduce excess inventory levels to free up cash. Use just-in-time inventory practices to minimize stock sitting on shelves.
IV. Working Capital Loans
Explore short-term loans or financing options aimed at boosting working capital. For instance, supply chain financing and accounts receivable financing can enhance your working capital situation. With supply chain financing, suppliers get paid early on their invoices, usually at a lower funding cost. Then, the buyer settles the amount with the financier on the invoices due date. On the other hand, accounts receivable financing gives you access to a credit line secured by your outstanding invoices, allowing you to unlock cash tied up in those unpaid bills. Both strategies help improve your working capital and optimize cash flow.
V. Improve Cash Forecasting
Cash flow forecasting enables your company to predict, analyze, and address the factors that will affect your working capital in the future. By understanding seasonal and cyclical events, you can make better, informed decisions on funding, investments, and capital expenditures. As a result, you can maximize the efficiency of working capital in the short term while minimizing long-term risks.
Ensure you differentiate between short-term working capital needs and long-term, permanent requirements. You may need to cut expenses to drive top-line growth. A detailed review of your business expenses could reveal ways to save money by decreasing expenses. Implementing these five strategies and carefully managing profit margins will improve your company’s overall financial health. Reviewing your processes every year helps adapt to business changes and supports growth.
Contact Aprio’s Advisory Services team to help support your strategic objectives Contact Tanya Owens or Donna Dominguez to help your business reach the next level.
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About the Author
Tanya Owens
Tanya brings more than 25 years of industry experience to her role as Director, Government Contracting Advisory for Aprio. She has a strong background in financial operations, business integration and process improvement. Tanya specializes in helping CEOs and Finance Executives of small to mid-size government contractors with modeling and forecasting, business process optimization and fractional CFO services.
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