Working Capital: Why It’s Critical and How to Free Up More of It

Working Capital: Why It’s Critical and How to Free Up More of It

Working capital is the money that fuels your business — the cash on hand that empowers you to keep the lights on and the wheels in motion. If you have ever struggled to meet the everyday expenses of your company, then you know all too well the value of effectively managing your working capital.

In short, sufficient working capital can help enable you to:

• Maintain smooth operations by preventing or minimizing disruptions in cash flow
• Strengthen relationships with suppliers and lenders as you consistently pay them on time
• Leverage growth and expansion opportunities as they emerge
• Build a strong credit history and score by demonstrating your commitment to fulfilling your financial obligations

In simple terms, working capital is the difference between your current assets (cash, inventory and accounts receivable) and current liabilities (payroll, taxes, rent, accounts payable, loan payments and other financial obligations that must be paid off within a year). It reflects your company’s short-term financial health and empowers you to continue building your business.

The more working capital you have on hand, the more options you have for growing and expanding into the future. For example, healthy reserves of working capital can fund new programs and investments, as well as one-time equipment expenditures and repairs. They can also serve as a financial cushion, helping ensure business continuity in the face of sudden revenue drops, unexpected cost increases, major disruptions such as natural disasters or data breaches, and other unforeseen circumstances.

Ideas for Increasing Working Capital

Strategic cash flow management, inventory management and planning are pivotal to building your working capital reserves. The following actions may support your efforts.

Accelerate receivables, decelerate payables. Holding onto your money longer can help ensure you have capital on hand to cover day-to-day expenses; that means collecting faster and paying more slowly. Prompt invoicing, early-payment incentives and well-negotiated payment terms may help you collect faster. On the accounts payable side, focus on negotiating longer terms as well as discounts, and paying on or just prior to the due date. Be careful not to delay too long: Making payments after the due date can compromise not only your relationship with the supplier but also your credit score.

To make these processes as efficient as possible, consider automating payables and receivables if you haven’t already. Electronic workflows set up to collect monies owed as soon as possible while paying bills as late as possible can help give you greater control over your company’s cash flow and working capital reserves.

Master inventory control. If your business involves a physical product, it’s important to get the balance of inventory right. While understocking can put you in a bind if you’re unable to fulfill orders, overstocking ties up too much of your working capital. Ensure that your team has all the tools they need to forecast accurately and keep inventory at ideal levels throughout the year. Digital inventory management tools can support their expertise by analyzing the implications of historical data and trends, seasonality, supply chain conditions and other relevant factors.

Streamline operations and avoid nonessential spending. Remember that efficiency supports your financial position not only as it relates to accounting practices but also the overall operations of your business. Optimize processes wherever you can. Identify areas where you can reduce costs without compromising the integrity of your products or services. And revisit your spending practices to see where you can tighten up on nice-to-haves, freeing up dollars that can be converted into working capital.

Know where you stand. Having continuous visibility into your working capital is vital to effective management and forecasting. You can tap into the capabilities of technology tools ranging from enterprise resource planning (ERP) systems, which centralize financial data and operations for comprehensive insight, to working capital management platforms, which provide specialized tools for cash forecasting, liquidity management and more. Used in conjunction with inventory management and AP/AR tools, these technologies can help you learn from the past, thrive in the present and anticipate the future.

When Working Capital Isn’t Enough

You can do everything right in terms of working capital management but still fall short when an opportunity or a challenge arises. For example, maybe you get a large, unexpected order that requires you to bulk up on raw materials and/or staff or buy a piece of equipment. Or perhaps you’re anticipating a growth spurt that you know will require more cash on hand. At times like these, you may want to check into financing options such as a business express loan, term loan or line of credit.

Let Dollar Bank help you find the solution that’s right for your company’s needs. Reach out to our team to discuss your working capital goals and needs.