Tips to Improve Your Working Capital

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Improving cash flow is always a worthwhile but sometimes nebulous goal for a small business. One way to better define this goal is to divide your cash into two buckets – long-term and short-term.

The short-term bucket is for cash you need to pay expenses over the next 12 months. The long-term bucket is for cash you need to pay expenses in the distant future, beyond the next 12 months.

Another name given to the amount of cash and resources you have available to put in the short-term bucket is working capital.

The Importance of Working Capital

Beyond just being able to pay recurring monthly bills, there are several reasons why having a healthy amount of working capital is important for your business.

  • Improved liquidity. By exhibiting a high level of working capital, businesses can ensure adequate cash levels are available to take advantage of unexpected expansion opportunities or to survive a severe downturn in revenue.
  • Operational flexibility. Adequate levels of working capital can be used to smooth out delays in receiving customer payments or navigating certain supply chain disruptions.
  • Increased business valuation. A business that has plenty of cash available to pay its monthly bills, weather an economic downturn and take advantage of expansion opportunities will fetch a premium when it comes time for you to put your succession plan into motion.

Tips for Improving Working Capital

  • Pay suppliers on time. Waiting as long as possible to pay a vendor may seem like a good strategy for improving short-term cash flow, but suppliers who are promptly paid may be more likely to be more flexible when it comes to prices and future payment terms.
  • Keep small expenses under control. It’s easy to ignore small expenses. But these incidental costs can add up in a hurry if you aren’t paying attention. Consider putting a policy in place with how to deal with and track petty cash expenses and other small expenditures.
  • Foster a good working relationship with your banker. A short-term loan or line of credit is one way to navigate a sudden cash shortfall. Of course you need to first qualify for the line of credit. Fostering an ongoing business relationship with a trusted banker can help you access emergency cash when needed.
  • Improving your working capital can be trickier than it appears. Please call if you would like to discuss ideas for improving your business’s working capital, for help calculating your inventory turnover ratio, or if you have any other cash flow questions.

Here are some cash flow management tips for your business as we head into a new year.

  • Have a plan to pay your bills. Forecast the flow of your key bills over the next twelve months. Review your bills, sort according to priority, and schedule payment dates so the most important items, like rent and payroll, are paid first. Then pay your bills on time, neither early nor late. Take as many discounts as possible.
  • Negotiate terms with suppliers. Some invoices are due on receipt; others, a few days later. Negotiate the longest payback terms possible and ask for early-payment discounts. A two-percent discount might not seem significant, but on bulk orders savings can accumulate. Depending on your industry, you might set up a vendor payment schedule that better reflects your accounts receivable payment behavior.
  • Quickly collect receivables. When a customer places an order, try to get paid as soon as possible by sending invoices promptly, confirm that the invoice was received, and immediately follow-up on past due payments. Also consider discounts to customers who pay quickly, and an option to pay invoices online instead of taking several days or longer for a check to arrive via mail.
  • Be smart with debt. As a general rule, consider taking out a loan of no more than 75% of an asset’s value, and aim for loan terms that don’t exceed the useful life of the underlying asset. Debt can be a valuable tool for growing and sustaining your business, but be careful not to overextend.

Please call if you have questions about how to be better at managing your cash in 2022.

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