Working capital is essential for the ongoing operation of any business.

But just having sufficient working capital is not enough to ensure success. Effective management is crucial for both smooth business operations and sustainable growth.

So, what exactly is working capital management and how is it best executed?

An Introduction to Working Capital

Working capital is the difference between the amount of money coming into your business, in other words your current assets, and the amount of money going out, i.e., your current liabilities.

In essence, it is the cash that your business has available due to income streams or investment.

The Importance of Working Capital

Working capital is important because it ensures you have enough cash flow to cover your day-to-day operating expenses, make the most of growth opportunities and ensure ongoing success. The art of managing working capital is about best optimising your short-term financial resources.

With efficient management, you can improve your business’s liquidity. In other words, you’re better able to meet any short-term expenditure obligations without any need to disrupt operations and without any unwanted financial strain.

With greater access to worker capital, you can take advantage of unexpected opportunities in the market and offer your customers/clients better services to help propel your business forward.

Ultimately, the more working capital your business has, the more you can invest, grow and boost profitability for your business.

Working Capital Formula

The working capital formula is quite simple and reflects its definition:

Working Capital = Current Assets – Current Liabilities

All this means that once you have deduced all liabilities and expenses from your assets and revenue, the leftover amount is referred to as working capital.

What do we mean by assets?

Current assets can include anything from inventory and cash to accounts receivable (i.e., the amount of money issued to clients by invoice but not yet repaid).

Similarly, current liabilities can include short-term debt, accrued expenses or accounts payable.

While simple, this calculation is an important and valuable insight into your business’s current and short-term financial health.

Strategies for Managing Working Capital

1. Optimise your inventory management

Stocking excessive inventory ties up valuable capital that could be used elsewhere in the business. The more optimised your inventory is, the better able you will be to free up working capital for use in other areas of the business.

How can you do this?

  • Regularly review inventory levels and compare it with fluctuations and averages in sales.
  • Implement a just-in-time ordering system to prevent excessive stock from building up.
  • Negotiate more favourable payment terms with your suppliers to ensure you don’t have to engage in unnecessary stockholding.
2. Manage Accounts Receivable Efficiently

Having an outsized number of invoices outstanding can prevent your business from having access to the working capital it needs to thrive.

A robust credit policy and efficient collection process will ensure timely payments from customers and clients. You can even offer early payment discounts to help incentivise faster payments, implement late fees for overdue invoices, or outsource collections.

Alternatively, you can consider Invoice Finance.

Invoice Finance is a customisable and flexible financial solution that allows businesses to access the working capital locked up in outstanding invoices before your customers or clients have settled their accounts.

3. Review Payment Terms with Suppliers

Your payment terms with suppliers can be an important component of working capital management. Negotiating extended payment terms with suppliers can ensure more favourable trading and help free up cash flow in the short term.

It is important that the payment terms you agree to are reasonable and manageable. Some suppliers may penalise late payments and this can negatively impact your working capital management.

4. Track Working Capital Metrics

Ongoing monitoring and analysing of the working capital metrics for your business can ensure you are on top of access to necessary cash flow.

Having current and updated key working capital ratios data will provide the confidence and peace of mind that you can cover operational expenses, invest in growth and ensure business success.

Without sufficient data and metrics, it can be hard to make informed decisions. As a business manager, it is critical that you understand your company’s liquidity and have enough information for efficient management of current assets.

Common Mistakes to Avoid for Better Working Capital Management

1. Overstocking inventory

As we mentioned above, holding excess inventory is not a good idea. Not only does it tie up your capital, but it increases storage cost and increases the risk of obsolescence.

2. Bad Credit Policies

While good customer service is great, offering overly generous credit terms that lead to delayed payments and cash flow issues is not.

3. Inefficient Debt Collection

If your accounts receivable process is slow or disorganised, you will find your cash flow significantly impacted.

4. Negligent Working Capital Management

Failing to be proactive and continuous in your management of working capital, for example in tracking metrics, can leave you vulnerable to nasty surprises. These can include liquidity problems and other issues that will hinder your business’s ability to grow.

For Custom Working Capital Solutions, ScotPac is Here

By implementing these strategies and practices you can take a proactive approach to effective working capital management.

With the right cash flow, your business will have the fuel it needs to rocket towards success.

If you are interested in exploring a tailored working capital solution to give your business the power it needs to reach its potential, get in touch with your local ScotPac New Zealand office today. Our lending specialist will be glad to provide you with a confidential, no-cost and no-obligation introductory consultation today.