Working capital in finance terms refers to the difference between your current assets and current liabilities. It is the source of your company’s ability to cover operational demands such as wages, inventory purchases, and debt obligations. As well as an indicator of your business readiness to adapt to unexpected events. To have a stable working capital level, there are three main factors you need to pay extra attention to: Accounts Payable (AP), Accounts Receivable (AR), and Inventory.
Optimizing Your Working Capital
To optimize your working capital means to have a greater control over your capital flow. For example, on the books you have a large capital but on closer inspection it turns out that most of your capital can’t be used immediately. So, as you perform an analysis on your capital sources, here are 4 practical measure to optimize your working capital:
1. Settle Your AP on Time Place an emphasis on settling the accounts with your supplier/creditors on time. This will build a positive working relationship with them that will allow you to negotiate future rates and terms. Subsequently, on time or early payments to your creditors and/or suppliers will help build up your credit score.
2. Speed Up Collections Positive AR is good but when it’s too large for an extended period, there might be some lag in your collection process. To get rid of it, make the process easier on you and your customers. This involves establishing clear payment terms, break up the payment deadlines, starting collections early, and knowing what your customers require on invoices.
3. Lower Inventory Days Being well stocked is necessary, but when it goes on for too long your inventory becomes a liability. Resulting in tied up precious working capital that could go obsolete. To avoid excessive inventory, keep track of lapsed time between selling your inventory and when you receive it (inventory days for short). Additionally, analyze the historical data of your inventory days for better scheduling of your inventory in low seasons.
4. Expenses Management Every business hates getting dragged down by additional expenses and chief among them is unforseen expenses. Although there is no way of accurately predicting them, past reports helps you stay prepared for them.
If your past reports show $500 to $750 as the cost of your equipment repair take the highest number and treat it as a guaranteed expense in your budget. This way, even if you won’t need it this month, you’ll automatically set aside some cash for any unforeseen costs. So nothing can catch you off guard.
Time to Seek Additional Capital?
Invoice factoring. When the pile of unpaid invoices grows taller, this is a route that will lift the burden of needing to constantly ask your customer to pay. Instead, lenders take on this responsibility and give you a lump sum amount in exchange of your unpaid invoices. The biggest advantage to this route is that those invoices are treated as the collateral. Placing no risk on your assets.
Alternative Lending. Alternative lending providers offer much easier access to financing options through their streamlined approach. Putting the entire process online Allowing you to get quotes on financing options like business line of credit or equipment financing from various lenders instead of just one. The primary advantage of this routes is that lenders have more flexible requirements and are more willing to work with poor credit history. Giving you a higher chance to qualify for a loan
Working capital optimization is a vital practice that should be built into your business sytem and planning. So that you’ll always have the needed liquidity and flexibility to adapt to any changes. This in turn will strengthen your qualification for a loan at the same time.