Finance for Non-Financial Managers: Working Capital

Dave JonesFinance for Non-Financial Managers0 Comments

working capital

Working capital is the lifeblood of all businesses and is the responsibility of everyone in an organisation. It is the money that is needed to run a business on a daily basis.

It has many names such as Net Capital Employed, Net Working Capital, Operating Working Capital and Working Capital Requirement. No matter what it is referred to as, it is all the same.

It is made up of inventory, all the products you have on your shelves

Plus account receivable or debtors, all the money your customers owe you.

Minus the accounts payable or trade creditors, the money you owe to your suppliers.

WORKING CAPITAL = (INVENTORY + RECEIVABLES – PAYABLES)

The lower the requirement for Working Capital, the more cash the business generates.
More available cash means more money to fund new projects, growth, new businesses and acquisitions.

Strong cash generation is a vital part of a business’ value.

Careful management of working capital can and does generate more cash for a business, which will be looked upon favorably by external analysts, existing investors and potential investors

Working Capital Drivers

There are 3 main drivers that can be managed in order to optimise working capital.

These drivers are:

1. Optimising invoicing and collection
Once work is completed or a service is delivered, you need to make sure that an invoice is issued as soon as is possible. After the invoice has been issued, you need to collect the money in the shortest possible time. The longer it takes, the higher the working capital and the more negative the impact on your cash balance. The invoice to cash cycle (the time it takes between the moment the job is executed and the moment money is collected) should be as short as possible.

2. Optimising inventory
Inventories immobilise cash until they are consumed, so reducing inventory levels reduces the working capital requirement. The key in any operation is to determine the optimal level of inventories needed, so that you do not put your business at risk, but also do not tie up too much cash.

3. Optimising supplier payments
You can optimise working capital by looking at cash outflows, in particular, by looking at the way you pay your suppliers. You need to negotiate the best payment terms to avoid paying too early. The later you pay your suppliers, the better it will be for your working capital and cash, since you will avoid using cash too early. The key word in this paragraph is ‘negotiate’. Good supplier relationships are also critical to a business, so you need to have a good understanding of your suppliers business in order to ensure payment terms remain fair.

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