How to manage working capital
Why it’s your responsibility to put working capital management at the core of your company’s operations
Martin Mitchell, head of operations at financial training firm CTG, explains why entrepreneurs should put working capital management at the core of the business' operations.
Many entrepreneurs think their business is financially sound if it's making profits, but that isn't always true. The demands of working capital mean that even profitable companies can run out of the cash that's needed to meet current expenses such as payroll, benefits, rent, and other liabilities, particularly during a growth phase.
If you can't meet your liabilities, you may be forced out of business, so managing working capital is a commercial imperative that needs leadership from the top.
Here are my tips for the processes and practices you need to introduce in your organisation to manage working capital effectively.
1. Get paid – quickly
Many businesses invoice at the end of the month and offer a 30 day payment period. If the sale happens early in the month that nearly doubles your debtor days. Ensure your business invoices customers when goods or services are sold, on a daily basis if possible. Then follow up each invoice – ensure it was received, check the customer agrees with the invoice and then actively chase payment – before the money is due. Debtors often use disputes or excuses to delay payment, so if you only follow up when payment is due, you won't receive payment on time.
The cost of chasing payments quickly mounts up and smaller companies simply can't afford to have accounting staff focused on this at the expense of other activity. You have two options, the first of which is factoring – selling your receivables to a third party for them to chase. This passes on the activity to another party while guaranteeing you a proportion of monies owed, but you lose control of your debt recovery and incur the costs of the factoring agency.
Arguably, a better alternative is to involve more people within the business itself. Salespeople can use their relationship with the customer to follow up on the initial invoice, ensure there are no disputes, and help to chase payment when it falls due. Alternatively, an administrative assistant with good ‘completer/finisher' skills can undertake the series of calls and emails required to chase payment and ensure that all communications are logged carefully.
2. Keep meticulous records
Salespeople, accountants and administrators need to record every communication – whether by letter, phone or email – including dates, times, what was said, and what was agreed. If your business can't rebut the excuses your debtor makes to avoid paying, it puts you at an immediate disadvantage. You should also employ the same tactics with your creditors, to ensure that you enjoy your agreed credit terms. Technology has made this process much easier, as emails are normally saved. It's a good idea to follow up every phone call with an email to recap.
3. Discount with care
Ironically, a successful sales team could have a negative effect on working capital if customers are offered discounts or extended credit terms. Ensure your salespeople know the limits – and impacts – of what they can offer and don't over-negotiate in order to close a sale. In addition, discounting tends to have hidden costs that aren't immediately apparent. Some accounting software packages will assume discounts are ongoing and consequently regular customers may pay a substantial part of their invoice at the right time, but leave some of the bill unpaid. Your business will then have to bear the cost of chasing that smaller amount.
4. Manage inventory
Controlling stock effectively has a significant positive impact. Focus on overall stock levels to identify lines that aren't selling rather than just ensuring popular stock lines are replenished, then lead the sales and marketing team in rationalising the number of lines you offer and focusing on the most profitable ones. Sourcing is also important. If possible, deal in consignment stock which can be held on your business premises but doesn't need to be paid for until you sell it on. This lowers your costs while maximising revenues, as will properly planning and managing stock levels to accommodate peaks and troughs in demand.
5. Secure good credit terms
Seek payment terms that at least match the terms you extend to your customers. Streamline buying relationships, perhaps by entering into a purchasing co-operative or by ensuring that subsidiaries leverage the organisation's buying power by negotiating better terms centrally. It's also sensible to consider how you deal with customers who are also suppliers – “netting off” your payment (i.e. paying them for what you owe, minus what they owe you) is much more time and cost effective for both parties.
Entrepreneurs are often meticulous about innovation and sales, but less rigorous when it comes to managing finance. Yet ultimately, it's your responsibility to ensure that your company has enough capital to meet its liabilities. You must take and share responsibility for the business decisions and internal processes that impact working capital. A few simple changes can make a huge difference to your company's chances of survival.
CTG provides financial training to global financial institutions, corporates and professional services firms.