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What is Working Capital Management?



The primary objective of working capital management is to optimize the balance between liquidity and profitability, by ensuring that the company has enough cash on hand to pay its bills and invest in growth opportunities while avoiding excessive idle cash that could reduce returns.

Working Capital Management Activities and Strategies

Cash Management

Managing the company's cash position, including cash inflows and outflows, to ensure that it has enough cash on hand to meet its obligations and fund its operations.

Cash Inflows

Working capital is used to manage the cash inflows of a business. When a business sells goods or services, it generates revenue, which increases its working capital and cash inflows.

Cash Outflows

Working capital is used to manage the cash outflows of a business. When a business pays for inventory, salaries, or other operating expenses, it uses its working capital and reduces its cash balance.

Forecasting Cash Flows

Working capital is used to forecast cash flows so that a business can anticipate its cash needs and manage its liquidity effectively. By forecasting cash flows, businesses can manage their working capital needs and ensure that they have sufficient cash on hand to meet their short-term obligations.

Managing Working Capital Needs

Effective working capital management is critical to cash management, as it ensures that a business has sufficient liquidity to meet its short-term obligations without relying on cash reserves. By managing working capital levels effectively, businesses can improve their cash flow and reduce their financial risk.

Investing Excess Cash

Working capital is used to invest excess cash in short-term investments, such as money market funds or certificates of deposit. By investing excess cash, businesses can earn interest income and improve their returns on working capital.

Inventory Management

Managing the company's inventory levels to ensure that it has the right amount of inventory on hand to meet customer demand while avoiding excessive inventory that could tie up cash and reduce profits.

Purchasing Inventory

Working capital is used to purchase inventory and raw materials needed for production. A company needs sufficient working capital to purchase inventory and maintain optimal inventory levels.

Managing Inventory Levels

Businesses need to optimize their inventory levels to ensure that they have enough inventory on hand to meet customer demand while avoiding excessive inventory that could tie up cash and reduce profits. This requires effective inventory management to balance supply and demand and to ensure that inventory levels are in line with sales projections.

Reducing Inventory Costs

Holding inventory for too long can increase carrying costs, such as storage, insurance, and interest. By effectively managing inventory levels, businesses can reduce carrying costs and free up working capital for other purposes.

Financing Inventory

In some cases, businesses may use working capital financing to finance their inventory. This can help businesses manage their working capital needs by providing short-term funding to purchase inventory.

Managing Obsolete Inventory

Obsolete inventory ties up working capital and reduces a business's overall profitability. Effective inventory management is critical to minimize obsolete inventory and preserve working capital.

Accounts Receivable Management

Managing the company's accounts receivable to ensure that it collects payments from customers on time and in full.

Cash Inflows

Accounts receivable represent the money owed to a company by its customers for goods or services provided. As customers pay their invoices, the company receives cash inflows, which increase its working capital.

Financing Accounts Receivable

Working capital financing, such as invoice factoring or invoice discounting, can be used to finance accounts receivable. This can help businesses manage their working capital needs by providing short-term funding to support their operations.

Managing Collections

Effective management of accounts receivable is critical to optimizing working capital. Monitoring collections, following up on late payments, and implementing accounts receivable management systems can reduce the time it takes to receive payment from customers and improve their cash flow.

Setting Credit Policies

Setting appropriate credit policies is important to managing accounts receivable. By setting reasonable credit terms, monitoring credit risk, and using credit scoring, businesses can manage their credit exposure and reduce the risk of non-payment.

Monitoring Accounts Receivable Metrics

By monitoring key accounts receivable metrics, such as days sales outstanding, businesses can assess their liquidity and identify opportunities for improvement. Reducing the time it takes to receive payment from customers can improve businesses working capital position and optimize their cash flow.

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Accounts Payable Management

Managing the company's accounts payable to ensure that it pays its bills on time and avoids penalties and late fees.

Cash Outflows

Accounts payable represent the money owed by a company to its suppliers for goods or services received. As a company pays its accounts payable, it uses its working capital and reduces its cash balance.

Negotiating Payment Terms

Negotiating favorable payment terms with suppliers can help businesses manage their accounts payable more effectively and optimize their working capital. By negotiating longer payment terms, businesses can free up working capital for other purposes and improve their cash flow.

Managing Payment Deadlines

Effective management of accounts payable is critical to optimizing working capital. By monitoring payment deadlines, avoiding late fees and penalties, and implementing accounts payable management systems, businesses can manage their cash flow and reduce their financial risk.

Monitoring Accounts Payable Metrics

By monitoring key accounts payable metrics, such as days payable outstanding, businesses can assess their liquidity and identify opportunities for improvement. By reducing the time it takes to pay their accounts payable, businesses can improve their working capital position and optimize their cash flow.

Managing Cash Flow

Accounts payable are closely tied to a company's cash flow, as they represent a significant cash outflow. Effective cash management is critical to managing accounts payable and optimizing working capital. By forecasting cash flows, managing working capital levels, and investing excess cash, businesses can improve their cash flow and reduce their financial risk.

Working Capital Financing

Businesses can use various financing options, such as short-term loans, lines of credit, factoring, or invoice discounting to obtain working capital to fund their operations.

Short-Term Financing

Working capital is often used to obtain short-term financing, such as lines of credit, trade credit, or factoring. By using working capital to obtain short-term financing, businesses can manage their cash flow and meet their short-term obligations.

Long-Term Financing

Working capital can also be used to obtain long-term financing, such as term loans or equipment financing. By using working capital to obtain long-term financing, businesses can invest in growth opportunities, such as expanding the business or purchasing new equipment.

Collateral

Working capital is often used as collateral for business loans or lines of credit. Lenders may require businesses to maintain a certain level of working capital as a condition of the loan in order to reduce their risk and ensure that the business has sufficient liquidity to meet its obligations.

Investment Opportunities

Effective working capital management can create investment opportunities for businesses. By managing their working capital effectively, businesses can free up cash for investment in growth opportunities, such as expanding into new markets or launching new products or services.

Financial Risk

Effective working capital management is critical to managing financial risk for a business. By managing their working capital effectively, businesses can reduce their financial risk and improve their financial stability, making them more attractive to lenders and investors.

Asset Optimization

Businesses can optimize their current assets by reducing idle cash, selling surplus assets, or monetizing their receivables through securitization.

Working Capital Metrics

Businesses can monitor key working capital metrics, such as days sales outstanding, days inventory on hand, and days payable outstanding, to assess their liquidity and identify opportunities for improvement.


Make Working Capital Work for Your Business

Now that you have learned some strategies for managing your working capital, start putting them to use and watch your working capital do the work needed to make your business profitable and attain long-term growth.

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Biz Tip Topic Expert: Nancy Mehlberg, CVB, EA

Nancy Mehlberg, CVB, EA

Nancy is a Principal with SVA Certified Public Accountants and helps clients improve their company profitability and protects their interests by clearly understanding their future goals. She works closely and proactively with clients with an emphasis in business and income tax planning and financial reporting.

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