Working Capital Management: What Data Matters?

If Microsoft were to liquidate all short-term assets and extinguish all short-term debts, it would have almost $100 billion of cash remaining on hand. It might indicate that the business has too much inventory or is not investing its excess cash. Alternatively, it could mean a company is failing to take advantage of low-interest or no-interest loans; instead of borrowing money at a low cost of capital, the company is burning its own resources. Most major new projects, such as an expansion in production or into new markets, require an upfront investment. Therefore, companies that are using working capital inefficiently or need extra capital upfront can boost cash flow by squeezing suppliers and customers.

Controlling when you pay your bills can incredibly impact your cash flow and working capital. By postponing the payment of your bills until the last moment, you can hold onto that capital for a longer period. Conversely, if your suppliers offer substantive early-payment discounts, you should cut those checks immediately and reduce your overall expenses. Accounts payable management strategies can be very important to improving your working capital. Utilizing accounts receivables technology to deliver invoices electronically can also potentially shorten the receivables period and the CCC.

Accounts payable automation trends drive efficiency & accuracy in financial processes. NetSuite has packaged the experience gained from tens of thousands of worldwide deployments over two decades into a set of leading practices that pave a clear path to success and are proven to deliver rapid business value. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. If you’d like more detail on how to calculate working capital in a financial model, please see our additional resources below. Learn more about a company’s Working Capital Cycle, and the timing of when cash comes in and out of the business.

• Working capital represents the money your company has to meet its day-to-day business expenses.
• This will help to reduce collections and improve cash flow on an ongoing basis.
• Make sure you have strong collection teams to chase delinquent customers.
• From small businesses to world-class enterprises, working capital is an important metric in assessing the long-term financial health of a business and ensures that adequate cash flow is available for short-term commitments.

If Company A has working capital of $40,000, while Companies B and C have $15,000 and $10,000, respectively, then Company A can spend more money to grow its business faster than its two competitors. Deloitte has assisted a number of companies in various industries with different levels of working xero community capital maturity. No matter how well-run the organization is, there are always working capital optimization opportunities. Fundamentally change the business model to deliver step-change improvements. Typical benefit improvement is 20+ percent of NWC and time to benefit of up to 12 months.

Cash Flow

When a business uses a line of credit, it’s common for cash balances to be low. If there are excess current assets, the additional resources can be spent on day-to-day operations. This is a great sign for the business and might indicate some flexibility in the use of your resources.

The simplest formula for improving the working capital position is to collect receivables early and slow down the payables. There should be enough funds for meeting short-term debts, but that should not come at the cost of losing return on investments (ROI) in assets. A change in working capital is the difference in the net working capital amount from one accounting period to the next. A management goal is to reduce any upward changes in working capital, thereby minimizing the need to acquire additional funding. Net working capital is defined as current assets minus current liabilities. Thus, if net working capital at the end of February is $150,000 and it is $200,000 at the end of March, then the change in working capital was an increase of $50,000.

In our hypothetical scenario, we’re looking at a company with the following balance sheet data (Year 0). In the absence of further contextual details, negative net working capital (NWC) is not necessarily a concerning sign about the financial health of a company. But if the change in NWC is negative, the net effect from the two negative signs is that the amount is added to the cash flow amount. If calculating free cash flow – whether it be on an unlevered FCF or levered FCF basis – an increase in the change in NWC is subtracted from the cash flow amount. An increase in the balance of an operating asset represents an outflow of cash – however, an increase in an operating liability represents an inflow of cash (and vice versa).

Another financing option recommended to free up current working capital would be to refinance an existing loan to earn lower debt payments with an extended loan term. Businesses focusing on optimizing working capital should hone in on specific working capital metrics and achieve double-digit percentage increases. According to the survey, the working capital metrics that are considered most important are debt to equity ratios, operating cash flow KPI’s, and accounts receivables turnover (or DSO). Companies with well-managed working capital will also measure days payable outstanding (DPO) to track success with accounts payables and days inventory outstanding (DIO) to track inventory turnover.

• With more control over supplier data and documentation, companies can ensure that the products they receive are delivered on time and meet quality standards.
• For new customers, perform a credit check or review their recent credit reports before offering any terms.
• Moreover, it will need larger warehouses, will have to pay for unnecessary storage, and will have no space to house other inventory.
• Electronic receivables will reduce manual processing, error, lost invoices, and will ensure proper management with reminders eliminating some timely inefficiencies.

Your business could be in trouble if that level dips into the negatives,  meaning you don’t have sufficient funds to cover your current bills. However, depending on the complexity of your company’s finances, knowing if you have the funds to cover your upcoming bills can sometimes take work. As we’ve seen, the major working capital items are fundamentally tied to the core operating performance, and forecasting working capital is simply a process of mechanically linking these relationships.

Current liabilities

A boost in cash flow and working capital might not be good if the company is taking on long-term debt that doesn’t generate enough cash flow to pay it off. Conversely, a large decrease in cash flow and working capital might not be so bad if the company is using the proceeds to invest in long-term fixed assets that will generate earnings in the years to come. Imagine if Exxon borrowed an additional $20 billion in long-term debt, boosting the current amount of $40.6 billion to $60.6 billion. The amount would be added to current assets without any debt added to current liabilities; since current liabilities are short-term, one year or less, and the $40.6 billion in debt is long-term.

Convert to electronic payables and receivables

It represents a major cash flow concern for many companies, which are continually in need of additional working capital financing. Working capital can also be improved by slowing down the release of accounts payable to creditors and suppliers. By integrating automation in the AP department, businesses can improve visibility over outstanding bills.

The DSO score is generally 45 or less and takes into consideration factors like industry, specific payment terms like Net 30 or Net 60 and how a company ranks against competitors. Working capital improvement starts at the point when a prospective customer applies for credit. You should investigate all credit requests of any size in detail, so that only creditworthy customers are granted credit. This can involve a review of an applicant’s credit report, calling its trade references, and examining its financial statements. A supplier management system that leverages automation, for example, can simplify the processes of supplier selection, onboarding, risk assessment, and contract negotiation.

Current Ratio and Quick Ratio

Are specific distributors more likely to sell to customers that don’t pay than other distributors? Adjusting credit profiles and terms or adding penalties or incentives can reduce this risk. Have customers send their payments to a bank lockbox, which can accelerate the flow of cash by a day or two.

However, these items are referred to as “fixed” assets because they often take more time and effort to convert into cash. So, while it may not lead to a fast boost to your capital, offloading any surplus office space or equipment usually makes sense. Alternatively, you can try leasing these excess resources to outside parties for an additional revenue stream. As you might suspect, changes in your working capital are tied directly to changes in your revenue and expenses. If you increase your sales volumes or receive interest or dividend payments from your investments, your bank account and working capital will grow.

This begins with examining your budget and breaking it down to its components. Make sure you’re not overspending in any area of your business finances. The 9 practices and adjustments we’ve outlined will give you the best chance at bolstering your working capital quickly. Of course, if you don’t have the resources or availability to tackle all 9 strategies at once — and honestly, who does? We’re so confident that this approach will drive you toward financial success and stability that we built our entire business around it. At the same time, consider limiting who can authorize spending to a select few employees.

Curent Ratio

Explore 7 proven accounting best practices for businesses to navigate the financial landscape with confidence and realize growth and stability. When your company is facing a cash flow crunch, this relationship will go a long way in receiving some leniency. Identifying delinquency early and taking prompt action will prevent accounts from aging too much.

For instance, automated workflows and verification steps within your A/R can help improve the accuracy and timeliness of your outgoing invoices. If you’ve noticed recently that you are regularly short on funds and have concluded that you need to increase your business’s working capital, this guide can help. So, let’s unpack the meaning of working capital and explore what it’s used for. Discover the 5 KPIs that will allow you to analyse your financial performance, predict growth and help you turn a profit. Transform your Accounts Payable operations with our expert insights on the five best practices that matter and unlock financial success.