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Effective Working Capital Management: 5 key Strategies

Effective working capital management is the basis of a good business. However, growing the company and increasing your sales will pressure cash flow. It will also offset the balance of working capital. It can be challenging as a growing business increases expenses and needs more working capital.

This article will examine five key strategies to manage your working capital effectively. First, let’s understand how to calculate the working capital.

How to Calculate the Working Capital?

We hope you are aware of the term’s assets and liabilities. You can calculate the Working Capital Management using the formula mentioned below.

‍The term “current” in accounting means you’ll use or pay for that asset or liability within one year.

Here are a few examples.

Current assets:

  • Cash
  • Supplies
  • Inventory
  • Prepaid expenses
  • Accounts receivable
  • Cash equivalents (treasury bills, notes, certificates of deposit, and so on)
  • Marketable securities (stocks and bonds)

Current liabilities:

  • Payroll payable
  • Accounts payable
  • Accrued expenses
  • Dividends payable
  • Income tax payable
  • Parts of long-term debts that are due in the next year.

5 Key Strategies for Effective Working Capital Management:

On-time payment to suppliers:

You might pay bills on time as a backward way of managing working capital since the money is leaving your accounts. However, this strategy concerns improving vendor management and creating better supplier relationships. If you regularly pay your bills on time, you help your vendors stay on top of their cash flow. Therefore, you get a reputation as a good and reliable client.

This will help you to create better supplier relationships. Good vendor relationships can help you negotiate better prices on ordering terms, such as discounts for buying in bulk. You must keep an eye on the DPO metrics.

It is your days payable outstanding (DPO), the number of days it takes you to pay your bills. If you are paying early, your DPO is shorter than your supplier’s payment terms, which is good for your business.

Improve your Inventory Management:

Inventory is an asset that may be converted to cash by selling it, but first, it must be purchased and stored. ‍If you are holding too much inventory, your storage costs will increase. You may even have to reduce prices to sell old inventories. This will lead to less money coming into your business. On the other hand, if you don’t have enough stock to fill orders, you will miss out on the income. However, later, this will lead to losing customers who may not return.

Here are a few inventory management techniques to improve your Working Capital Management:

  • Regularly check your inventory levels: This will help you to know when you have too much or too little of an item. You can then adjust your purchases accordingly.
  • Measure days inventory outstanding (DIO): It measures how many days an item sits in your inventory before it’s sold. It tells you about your inventory turnover rate. A shorter DIO is better since you’re selling and converting to cash faster.
  • Improve the inventory turnover rates: If you start measuring the DIO of your items, you’ll be able to see which products move fast and which move slow. Now, look at your slow-moving items and brainstorm how you can improve their turnover. ‍

You can even consider using the just-in-time (JIT) inventory system. It means you order items before you’ll need them to meet demand. This reduces your storage costs and avoids the need to discount old inventory.

Use electronic payables and receivables:

Like a paystub generator, there are many tools and software that you can use in the organization to record payments and receivables. You can reduce the receivables period by having a good collections system. One such method is sending out invoices using an Invoice Generator as soon as possible. Companies need to look into their invoicing processes to reduce errors that may be causing invoice delays to debtors. Such errors include manual processing errors, lost invoices, and so on.

Nowadays, the use of electronic transactions has transformed payment processes. Electronic payables processes like purchasing cards can increase Working Capital Management in a company’s accounts payables. Automated payments and electronic payment processes can offer savings on rebate structures and significant cost reductions. 

Cost monitoring and control:

 As a business owner, you must know that “it takes money to make money.” However, there is a difference between smart business investments and unreasonably high costs. You need to monitor the cost before you start controlling it. You can begin by creating a separate bank account for your business. It helps in separating personal expenses from operating costs easily.

This will help you monitor how money flows in and out of your business over time. You will be able to understand your normal expense levels. It can even invest in accounting software that helps you categorize expenses. You can cut costs by looking at your high-spend categories and controlling them. 

Get sufficient financing:

Working capital funding required to expand working capacity needs adequate cash. It helps to finance present operations without taking a great deal of risk. You should analyze working capital KPIs and determine working capital needs. It helps businesses select the right financing solution and adequate fund size for future operational needs.

You can opt for short-term business loans or even finance fixed assets with a long-term loan to get a healthy cash flow. You can use existing cash flow to pay suppliers or fulfill purchase orders. It will help you earn strong relationships, secure discounts, and increase cash return on asset investments.

Conclusion

A strategic and implementable approach to Working Capital Management should include inventory management and cost monitoring. It also involves getting sufficient financing and timely paying your vendors. Working Capital Management can generate more cash for a business, increase operational efficiency, and raise profitability and potential growth of the company. 

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