Improve Working Capital Management

Working capital is the lifeblood of your company. The excess of current assets over current liabilities, it has the power to create or destroy value. Three key components of working capital are inventory, accounts payable, and accounts receivable.

By reducing the cash conversion cycle – a key metric monitoring the length of time between when a company buys a product from a supplier and the collection of payments from customers for that product – companies can increase profitability significantly. The cash conversion cycle measures how fast a company can convert cash on hand into even more cash. The longer it takes a company to turn raw materials into sales revenues, the longer that company’s working capital is tied up and can’t be utilized to grow its business and increase profits.

Smart, efficient management of working capital can potentially free up cash for other uses that can build company value. The extra cash can also reduce the company’s reliance on debt or other forms of external financing while, at the same time, help to strengthen the balance sheet and enhance operational performance. And, depending on the company’s plans for growth, the extra cash can also be used to build value through mergers and acquisitions.

Cash Management Culture

As a business owner, you can provide the leadership needed to build a cash management culture that includes a formal working capital strategy. Your CFO or finance leader can help establish the structure needed to support working capital improvements. Because working capital touches so many different parts of your business, the finance leader can collaborate with other company leaders to add the program to their systems, analytics, and performance metrics.

There are levers throughout a business that can help drive working capital improvements, such as managing inventory more efficiently, embedding specific working capital metrics in forecasting, and improving the management of accounts receivable and accounts payable. Metrics should be built into the improvement program’s goals and used as a consistent feedback mechanism so that finance can monitor the program’s effectiveness and impact. Additional measures can be used to determine the capital required to fund manufacturing processes or to create dashboards that provide daily views of metrics that impact cash flow and working capital over time.

How do you sustain working capital improvements?

To sustain working capital improvements, you can create company-wide incentives that foster management focus and change, as well as real links to business performance and overall compensation. You should also have the flexibility to adjust for external factors that may adversely affect working capital, such as changes in the global economy, the limited availability of financing resources, and suppliers who are unable to meet company needs because of their internal capacity challenges.

Approaches to improving working capital management will vary depending on your industry and your company’s situation. Still, they should have three overall objectives: (1) reduce inventory, (2) speed up the collection of receivables, and (3) reconsider payment terms.

Do one thing: Determine what you can do to reduce inventory, speed up the collection of receivables, and improve payment terms. These activities will increase your company profits and reduce your cash conversion cycle.

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My article, Free Up Cash: Cross-Functional Best Practices For Managing Working Capital, made its debut in Strategic Finance magazine. The magazine is the publication of IMA® (Institute of Management Accountants). Click here to see the full article.