Cash is often referred to as “King” when it comes to operating a business however, working capital management is the driver of when the cash is utilised. Here we explore the importance of working capital and the three pillars of managing it.
Working capital is made up of current assets and current liabilities, and these normally include net cash, debtors, inventory, creditors and other payables. Working capital management is effectively managing these assets to drive the business’ profitability and increase its value.
While working capital management is often overlooked as generating little benefit to businesses and is frequently considered the accountant’s responsibility, it’s actually an operational issue that is a key part of business. Effective working capital management has a positive impact on overall financial performance of an entity; partly through lower interest costs, proactive debtor management (less bad debts) and increased inventory turn. The lower the amount of working capital required in a business, the more funds are available to distribute as profits to its shareholders, pay down term debt or reinvest into business growth through new opportunities, locations, or product and service offerings.
Between the global pandemic, supply chain and geopolitical issues, the last couple of years have been rocky. The impact of the COVID-19 pandemic has depleted the cash reserves of many businesses and stretched their working capital.
Meanwhile, as a result of supply chain issues, businesses are typically holding higher inventory values due to increased lead times and unknown shipping delays. This approach is understandable, given that sales would be impacted if inventory is not available, however having the wrong mix of inventory can also be detrimental to a business.
Pillar one
One way businesses can increase the flow of cash into their bank account is to lower the inventory turn days. Managing inventory levels and mix should be a joint effort between the people or teams responsible for purchasing raw materials or finished goods, manufacturing, finance and sales. Understanding exactly what is already in stock, the current and upcoming demands of customers and consistently communicating with suppliers and logistics providers to understand lead times, will help manage inventory to support sales and minimise excess stock levels. Manufacturing businesses should ensure they have enough time between receiving their raw materials and manufacturing to meet customer demands.
Pillar two
Another way businesses can improve their working capital is turning debtors into cash faster. Things to consider include:
- Should terms of payment be updated?
- Should customers pay upfront in part or full, or in seven days, rather than on the 20th of the month? Are there effective collection procedures?
- Are terms of contract and milestones being invoiced correctly?
- Are invoices being sent in a timely manner?
- If businesses are receiving a deposit, is the deposit high enough?
Pillar three
Lastly, the negative working capital items – overdrafts, credit cards and creditors – need to be considered. Businesses should consider the timeliness of payments in line with agreed terms such as:
- Are invoices paid before the due date?
- Can items being paid for on the credit card be invoiced and paid on the 20th.
- Will suppliers give an early payment discount?
- Is the overdraft nearly always ultilised and should be replaced with a term facility at a lower interest rate?
Managing each of the three pillars of working capital management will assist businesses to increase cash availability and improve operational efficiency.
Written by Lee Billington (Lee is a PwC manager and advisory)
