Working capital –unlocking your potential
While most of think of working capital as the funding we need to manage our debtors, stock and creditors it is much more than that. Working capital goes to the core of your business model and may help your business achieve greater success.
There are three main considerations when looking at working capital
- Policies and procedures: This is your business model. When setting your policies and procedures it is all about adding value to your customer, making it easier for them to deal with your business. But remember by adding value this will impact operations and funding, so make sure this is taken into account with your pricing.
- Efficiencies: If policies and procedures are not operated efficiently, they could impact the customer experience, increase your costs and funding requirements.
- Funding: Your policies and procedures and efficiencies along with seasonal fluctuations should determine the amount of funding your business will require; it is then important to select the most appropriate forms of funding to match your businesses working capital requirements.
Let’s have a look at how these considerations may impact the major working capital areas of your business.
Collections, Debtors, Accounts Receivable
The faster you collect your money and have it available for use the less cash you need to operate your business.
- Policies and procedures: Do you want to collect your money on delivery or give credit terms? While this may be partly determined by your industry, always remember it is about adding value for your customer. If you give credit terms: who to?; do you take a deposit up front?; do you take progress payments?; or is it 7 day, 14day , 30day or longer terms.
- Efficiency: It is important to invoice at the earliest possible time to start your credit terms and give your customers plenty of time to prepare to pay you; If you are not paid on the due date, follow up by phone the next day; Make it easy for your customers to pay you by understanding how they want to pay e.g. cash, credit card, direct debit etc; Have an aged debtor listing to know which customers are falling behind in payments and have a strategy to collect hem.
- Funding: If you have given credit it will need to be funded. There are three main sources of funding: 1.Equity, i.e. how much you have put in; 2. Suppliers who give credit terms; and 3. Finance such as an overdraft, invoice finance or a business loan.
Payments, Creditors, Accounts Payable
As mentioned suppliers who give credit terms are a source of funding for your business. The longer terms that can be negotiated the more working capital available for your business. Remember that your suppliers are integral to your businesses success, so honour your commitments,
- Policies and procedures: negotiate payment terms, if possible, with all your suppliers; pay your suppliers on time just as you would like to be; while having longer terms is the general rule, if a supplier offers an early payment discount, take it, if your cash flow permits.
- Efficiency: check invoices for accuracy and validity; if correct, process invoices into your system as soon as possible; book payment in through online banking on the due date at the same time as processing to avoid double handling; keep an aged creditor listing .
- Funding: Using the interest free period on a Business Credit Card could give you longer terms; some large one of bills such as insurance or vehicle registrations could be financed using Insurance Premium Funding, some suppliers may take a bank guarantee instead of requiring an upfront payment or security deposit.
Stock, Inventory, Work in Progress
The longer you hold inventory or take to finish a job the more cash will be required to operate and the more costs your business will incur from storage, to unsaleable stock, unbillable hours and the funding costs.
- Policies and procedures: Do your customers need the stock available immediately or can they wait; how much range do your customers actually need; always remember to buy less more often. Do regular stock takes.
- Efficiency: do you have a good inventory recording system or timesheets; do you know minimum reorder quantities and delivery times from your suppliers; do you have a purchasing forecast based on a realistic sales forecast; is your inventory easily accessible and kept in good order.
- Funding: Again the three funding sources; 1. Equity; 2. Creditors; 3; Finance such as an overdraft; or trade finance (if you are importing goods); or a business loan.
Working capital can be an Achilles heel for some businesses if not thought out and managed well. But if you set your policies and procedures with your customer in mind, operate your working capital efficiently and fund it appropriately, you may be able to unlock the potential here and drive your business to greater success.
Written by Rob Lockhart, Westpac’s Davidson Institute.