Improve Cash Flow and Enhance Working Capital With These Strategies
The working capital of a business is the cash available to spend immediately. In accounting terms, working capital is defined as the current assets, less the current liabilities.
If you have negative working capital, your business is in serious trouble. But merely having positive working capital is not enough. Ideally, a company should be aiming for a ratio of current assets to current liabilities of 2 to 1. If you hit that 2:1 ratio, you will be able to manage your cash flow comfortably, and you will have the leeway to cope with the usual peaks and troughs in profitability.
The strict accounting definition of working capital, however, is only a part of the equation. For example, you could have positive working capital and have a large amount of cash tied up in unpaid sales invoices. That situation could give you a healthy working capital ratio and a cash flow problem.
Here are ten strategies you can adopt to increase the available cash and the working capital in your small business.
1. Review Gross Margins
When you want to improve your working capital, you need to consider the underlying causes of the issue as well as the short-term fixes. If you are consistently not generating sufficient profit, you will need to review your gross margins. Investigate the possibility of increasing prices slightly, and look at where savings might be made on your direct costs. Even a small increase in profitability will increase your working capital in the long term.
2. Review Overheads
Look at where savings might be made on your overheads. Review your suppliers to identify less expensive vendors, or try negotiating with existing suppliers to get better terms. Also consider if you are spending money on unnecessary luxuries. Managing overheads is essential at any time, but it is also another long-term strategy to improve working capital.
3. Inject More Capital
You might want to consider making a further investment in the business to improve working capital, or you could try to attract some outside investment. An injection of cash in return for equity will provide the company with more liquid funds. However, it would be advisable to make sure that you understand the underlying cause of the lack of working capital before injecting further funds into the business. And, of course, bringing in outside investors will dilute your share of the equity.
4. Obtain Financing
Short-term borrowing or financing will give you greater cash flow flexibility. However, because short-term lending is a current liability, it will not improve your working capital situation. If you take out a long-term business loan, though, you will increase both your available cash and your working capital. However, just as is the case with raising more capital, it would be unwise to borrow to improve working capital before rectifying the underlying profitability issue.
5. Manage Your Invoicing and Receivables
Any delay in the raising of sales invoices will reduce your working capital. So, ensure that invoices are sent to customers as soon as the product or service has been delivered. You will also need to revisit your collection procedures because late-paying customers will be negatively affecting your cash flow. Chase outstanding invoices as soon as they become due. And consider offering incentives to pay early, such as early settlement discounts.
6. Consider Invoice Factoring
Invoice factoring is a fast and easy way to improve cash flow. And, because you sell your invoices to a factoring company, the funds you receive do not appear on the balance sheet as a loan. Factoring sales invoices provides access to the cash due from sales almost immediately and smooths out the cash flow. Factoring give you a cash injection and makes cash flow management more straightforward.
7. Manage Your Payables and Debt
It may seem counterintuitive to pay debts on time when you are dealing with a cash flow shortfall. In the long-term, though, paying loans and vendors on time will improve liquidity and increase working capital. Leaving debts to build up can lead to a more severe cash flow crisis later, and paying people on time generates good-will that you may have to rely on further down the line. Paying vendors according to their terms will also put you in a stronger position when renegotiating pricing.
8. Lease or Rent Equipment
Leasing or renting will save you needing to make large, one-off payments for assets. Leasing and renting spread the cost of purchasing assets, which leaves more cash in the bank and makes managing cash flow less of a challenge. Renting and leasing may appear to be a more expensive way to acquire assets, but if you offset the costs of these financing methods against the positive effects of the increased working capital, you may still find that this is an effective strategy.
9. Reduce Inventory Levels
Inventory is a current asset, so it is included in the accounting calculation of working capital. However, large amounts of slow-moving inventory will reduce your available cash. Review your purchasing policy to see if you can buy stock in lower quantities more frequently, and consider removing slow-moving items from your product lines. Increasing the inventory turnover rate will increase the amount of cash you have available to spend.
10 . Resolve Disputes with Customers and Vendors
Disputes with customers prevent sales invoices from being turned into cash. So, try to resolve customer disputes as fast as you can. It may even be beneficial to accept less than the face value of an invoice as a settlement in some situations, if it will avoid complete non-payment. So, don’t let your stubbornness get in the way of getting your hands on most of the cash. Try not to let disputes with vendors drag on, too. Even a disputed vendor invoice remains a liability until it is settled. And it is invariably better to resolve conflicts with a compromise than wind up with an expensive lawsuit on your hands.
The Bottom Line
The critical thing to take away from the above points is that you must fix the underlying problem before borrowing to improve working capital. Factoring sales invoices, reducing inventory, and even paying vendors late will improve short-term cash flow. However, if your business continues to leak cash, it won’t be long before you find yourself with the same cash flow issues once again.
About Universal Funding
Universal Funding is a privately-owned funding source that has funded thousands of businesses and more than $2 billion since 1998. We turn your accounts receivable into the funding you need through invoice factoring and can have cash in your hands in a matter of days.