A company’s working capital ratio provides insight into its ability to meet current obligations as they become due and to leverage short-term growth strategies. Executives place a significant emphasis on working capital management to bridge a gap between cash receipts and disbursements, and to ensure the money is invested appropriately in assets that will generate profits.
Although the working capital management process is often viewed as a daunting task, consider these key factors:
Analyze the operating cycle.
Operating cycle analysis provides insight into the number of days an entity funds its investments in products or services. The “float period” begins with the procurement of materials and ends with collection from customers. The operating cycle is computed by adding inventory days and accounts receivable days, minus accounts payable days. Areas of improvement are proper inventory levels, frequency of invoicing, customer terms, and payment arrangements with vendors.
Set realistic expectations.
External and internal pressures can place an undue influence on producing quarterly results period after period; excessive focus on this can produce a flattering but inaccurate depiction of working capital. Similar to budgets of anticipated growth and increased profits, companies must provide a factor for unexpected declines including market cycles, loss of a prime customer, pending or threatened litigation, and penetration by competition.
Manage available cash.
“Cash is king” is a frequent mantra in business. The basic process in managing cash is clear—maintain an adequate level of cash to meet current obligations and invest idle cash into earning assets. Companies with available funds may be in a position to negotiate with vendors to provide discounts for more rapid payments or invest in growth strategies for future benefits.
Seize the opportunity.
Be innovative in your overall approach by including operational and financial skills in the working capital management process. A holistic company approach can assist in identifying and implementing strategies, setting targets, and measuring performance levels for improvement. Accountability of the various function centers often leads to quantifiable results in working capital as the company uses various agents for change.
In the past, businesses routinely turned to an existing line of credit, corporate credit cards, or other lending relationships to fund working capital needs. Today, businesses have been forced to revisit their working capital management techniques based on increased demands and the strains of the financial markets.
Robert S. Olszewski can be reached at Email or 215.441.4600.