Working capital represents the money your company has to meet its day-to-day business expenses. It’s the amount of cash in your company’s pocket. Effectively managing working capital is critical to ensure your business can meet its obligations and avoid bankruptcy.
Working capital is calculated by subtracting current liabilities from current assets.
Yes, you want to have positive working capital, but the goal is to have $2 in current assets for every $1 of current liabilities. A company with a 2:1 ratio is effectively managing its working capital. A company with negative working capital is in serious and possibly immediate trouble, but any company with a working capital ratio of less than 2:1 could be in trouble.
To ensure your company has enough money to meet its daily financial obligations as well as to fund normal business operations, you must efficiently and effectively manage working capital. Too little working capital could lead to bankruptcy while too much working capital could lead to decreased profits and shareholder value.
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Ways to Improve Working Capital
You can improve working capital by bringing it as close to the ideal 2:1 ratio as possible. Below are six strategies to improve insufficient working capital. Each of these strategies requires that you analyze a number of areas within your business to find ways to adjust processes and improve efficiencies in order to reduce expenses and increase positive cash flow.
1. Improve Accounts Receivables Collections
Are accounts receivable being collected in a timely manner? Encourage customers to pay on time by offering quick payment incentives. In addition, motivate your collections team (if you have one) with internal programs that offer incentives to collect outstanding invoices within the invoice payment terms.
2. Improve Accounts Payable
Negotiate better payment terms with materials suppliers and distributors (or replace them with new suppliers and distributors) and improve management of the payment process. You should review the payment terms on your accounts payable as well as the payment terms on your accounts receivable. Balancing these terms so your company is in the most favorable cash flow position is critical.
3. Negotiate Better Pricing with Suppliers
You should review all supplier contracts and negotiate better pricing whenever possible. If a supplier isn’t willing to negotiate more favorable terms for you, then you might need to replace them. Don’t let loyalty get in the way. This is your business, and you need the best working capital position in order to survive and thrive.
4. Reduce Expenses
Review your fixed and variable costs to determine if there are areas to improve cash flow. For example, office supplies, equipment, and technology all represent expenses that could be reduced with negotiations, new suppliers, and so on.
5. Segment and Analyze for Credit Risk
Analyze your customers and segment them by their likelihood to repay you. This will help to reduce collections and improve cash flow on an ongoing basis. You can also do this analysis for all of your distributors. Are specific distributors more likely to sell to customers that don’t pay than other distributors? Adjusting credit profiles and terms or adding penalties or incentives can reduce this risk.
6. Review Tax Opportunities
Is your company taking all of the tax breaks it can? Is it overpaying taxes? Review all current tax codes to ensure your company is always in the best tax position possible.
What if You Have Excess Working Capital?
If you have excess working capital, then you should be using it to generate an increase in profits. Stay tuned for my next article on Women on Business to learn three ways to do it.
Susan Gunelius
Susan Gunelius is the Founder and Editor-in-Chief of Women on Business. She is a 30-year veteran of the marketing field and has authored a dozen books about marketing, branding, and social media, including the highly popular Ultimate Guide to Email Marketing, 30-Minute Social Media Marketing, Content Marketing for Dummies, Blogging All-in-One for Dummies and Kick-ass Copywriting in 10 Easy Steps. Susan’s marketing-related content can be found on Entrepreneur.com, Forbes.com, MSNBC.com, BusinessWeek.com, and more. Susan is President & CEO of KeySplash Creative, Inc., a marketing communications company. She has worked in corporate marketing roles and through client relationships with AT&T, HSBC, Citibank, Intuit, The New York Times, Cox Communications, and many more large and small companies around the world. Susan also speaks about marketing, branding and social media at events around the world and is frequently interviewed by television, online, radio, and print media organizations about these topics. She holds an MBA in Management and Strategy and a Bachelor of Science degree in Marketing and is a Certified Professional Career Coach (CPCC).
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Thanks Susan for sharing a great ways to improve your working capital. This is essential to growing your business. Here are some other ways to improve your company’s working capital.
#1 – Offer early payment incentives
#2 – Introduce credit card payment options
#3 – Consider alternative financing
I hope, These ways are very helpful to improve your working capital.
Hi Barry,
Thank you for providing these additional tips!
Thank you very much Susan!