When it comes to financial performance, businesses often focus on the bottom line and if they’re making a profit. But there’s another important number to watch, which shows if the cash in your business is being used efficiently. Understanding this figure can be the difference between a business remaining static or missing opportunities and growing.
If you’re looking to raise debt or equity finance, first check your Working Capital, or more importantly, your net operating working capital. You might be surprised by how much cash you actually have.
Defining working capital
Working capital is a measure of the money available for a company to run their day-to-day operations. Specifically, Net Operating Working Capital (NOWC) is calculated by taking the current assets required in operations and subtracting non interest-bearing liabilities. This is one of the foremost indicators in assessing a company’s liquidity in the short term.
When you calculate a company’s net operating working capital you are taking steps to better understand the company’s financial capabilities on a day-to-day basis. You can even figure out if the operating capital is right for your business growth and what to do to release any tied up cash.
You can then look at a business’ cash conversion cycle to uncover significant financial intel to help build a business without the financial drain.
Defining cash conversion cycle
The cash conversion cycle gauges the effectiveness of a company’s management and the overall health of the company. It measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash.
When you take control of your cash conversion cycle, you remove the negative impact from late paying customers, and poor credit terms with suppliers. This is why many businesses are seeing a cycle of extended and/or late payments from their customers. These customers are savvy and understand paying later has a positive impact on their cash conversion cycle whilst reducing pressure on their net operating working capital.
Dealing with cash flow interruptions
To take on these types of challenges, it is very beneficial to work with a financial expert. What comes as a surprise to some of Fifo Capital’s clients is that we can advise businesses on the financing options that are best for them, and also help them to develop solutions that don’t require financing. Fifo Capital won’t push a client toward a financing solution if it won’t leave them in a better position, because we need them to succeed in order to retain their business. Instead, the goal is to find the best way to explicitly manage the variables that make up a business’ working capital.
1. Boost accounts receivables
Unlike a business’ operating capital, working capital is about short term liquidity. This means that adjusting your working capital isn’t always about simply getting more money, but rather about getting access to funds sooner. A great way to do this is to offer early payment incentives to customers. When you need an early payment, simply offer the relevant client a discount for early payment.
If clients don’t cooperate, you can still move on to use a financing solution. Invoice financing allows you to achieve a similar effect using your financial institution as an intermediary.
2. Limit or defer outgoing payments
After negotiating extended payment terms, businesses can sometimes get significant discounts by offering to pay suppliers early. Doing so habitually can save a business thousands of dollars over the course of a year. Better yet, it means that when working capital is too low, businesses can simply delay payment to the normal due date to recover.
If early payment isn’t an option, or the business needs more time, they can use supply chain finance to defer payments for a longer period. This allows a business to pay a supplier out of a third party credit fund that can be paid off at a later time.
3. Manage inventory
Businesses, customers, and industry environments are not static. Customer preferences, obsolescence, production costs, and competitors can all affect how various products perform in any given month or quarter. To be successful, businesses need to track how different products perform, and make adjustments as quickly as possible to prevent overstocking products that won’t be moved in a reasonable amount of time.
Expert financial support is an invaluable resource for business owners
It’s not uncommon for business owners to ignore all this work in favour of simply keeping enough working capital on hand to deal with any eventualities. This, however, makes them less competitive, and can leave them blind to potential risks. Good financial management can often help in identifying potential cash flow issues long before they arise. More importantly, an expert can help businesses to come up with customised, out of the box solutions that are tailored specifically to their business.
As a result, businesses who work with financial experts can budget more confidently, and invest more of their working capital into growth and innovation. By understanding working capital, and giving it the attention that it is due, business owners can empower their companies and make them more competitive, more financially stable, and better able to manage disruptions of all kinds.