Working capital is the money needed for day-to-day business operations and is often a measure of a business’s liquidity, efficiency and financial health.
To ensure your business has adequate working capital, the working capital cycle should be applied. The working capital cycle is the length of time from the purchase of inventory to the receipt of cash from customer sales.
The cycle consists of four elements: cash (funds available), creditors (accounts payable), inventory (stock on hand), and debtors (accounts receivable). Maintaining good cash flow requires control over each component. Ways to improve working capital:
To collect payments from debtors early, consider:
- establishing a credit policy
- invoicing early
- reducing payment terms
- stop supplying credit to debtors that do not pay
- following up on overdue accounts
- offering early settlement discounts
Inventory can tie up a large sum of your working capital; reducing inventory through the just-in-time model can increase efficiency and eliminate waste. The just-in-time inventory model is beneficial as it allows for quick changes to customer needs and frees up working capital to better meet financial obligations.
Managing cash outflows
Managing the money you owe to creditors is just as important as managing your accounts receivable.
To ensure your cash outflow meets your obligations:
- consider early payment discounts
- prioritise suppliers
- ensure the accuracy of invoices before making a payment
- only make payments when they are due