The modern business environment underscores the need for a strong commitment to working capital management. As the economy responds to ongoing financial and sociopolitical uncertainty, investment money flows much less freely. The cheapest, easiest and fastest way to access more cash is to develop effective working capital management strategies.
Working capital management is not merely a financial metric to set, it’s a strategic priority to develop. The top midmarket companies manage their working capital up to four times more effectively than the rest of the field, which gives them better cash flow and a significant competitive advantage over their peers.
Working Capital Management in the Midmarket Context
Working capital is the difference between a company’s current assets and liabilities, expressed as operational liquidity. It represents a company’s capacity to cover its daily operations. Working capital management includes the entire spread of strategies and tactics used to ensure and improve that liquidity.
Savvy investors are keenly aware of the importance of a company’s good working capital management strategies. Efficient use of working capital demonstrates both thorough analysis and flexibility and can noticeably increase a company’s valuation. Extra resources that increase the potential for acquisitions are also attractive to forward-thinking investors.
Working Capital Matters More Than Ever
Although inflation has slowed its meteoric rise, it still remains high. Slowly dropping interest rates add extra financial pressure on businesses and consumers alike. Debt service is more expensive than before, and borrowing is a chancier proposition. Companies seeking to grow need the competitive edge of effective working capital management strategies.
A study of Qatar manufacturers revealed that companies with strong working capital management strategies were more profitable than their peers. Two strategies that provided significant dividends were shorter collection periods and cash conversion cycles coupled with longer payable and inventory turnover periods.
Increased liquidity allows burgeoning companies to take advantage of growth opportunities as they arise. M&A and capital asset acquisition decisions cannot always wait for negotiated financing; the companies that can respond most rapidly are the ones that evolve to the next level.
Geopolitical instability also remains constant around the world, threatening value chains both up- and downstream. Adept management of working capital provides companies with a safety net, ensuring cash flow even in cases of supply chain disruption.
The Need for a Cross-Functional Approach
As with all strategic vision, the plan for working capital management must come from the top. But creating effective working capital practices takes a company-wide effort, requiring cross-functional collaboration and strong relationship building.
Interdepartmental collaboration is required. Setting metrics and enacting procedures requires buy-ins from operations, procurement and sales in addition to the finance department. The CFO’s role in the process is multifaceted, steering teams to drive collaboration and meet targets, calculating ratios and streamlining net operating cycles.
Key Components of Working Capital Management
As businesses’ offerings and territories vary, so should the details of their working capital strategies. Online retailer Jimmy Beans Wool focused on meticulous accounts receivable practices and careful inventory management. The company’s increased liquidity negated any need for external financing and allowed it to expand its product line.
Digital mailroom Earth Class Mail chose to optimize its accounts payables and receivables, implementing subscription services, immediate invoicing and prompt collections. The resulting cash boost let the company scale nationally and led directly to its successful acquisition.
CFOs should first perform a thorough assessment to know where to start building their plan. The areas to assess include:
- Accounts payable & receivable practices: Does your company pay invoices only when due? Do you investigate discounts when paying early? Do you invoice promptly, charging (and collecting) interest on late payments?
- Cash management: Accurate and timely needs forecasting and tracking of the flow of cash in and out are extremely important. You need to know exactly where you stand before you can improve your position.
- Inventory optimization: Too much standing inventory ties down cash flow; not enough can impact fulfillment. Depending on the nature of your business, the balance may vary.
- Targets and metrics: Working capital management goals should reflect the company’s wider operations and ethos while being realistically achievable.
- Technological tools: The current market offers tools to analyze data, improve AP and AR practices and track the flow of inventory, along with dashboards to provide visible metrics.
The Challenges of Managing Working Capital
The primary danger of working capital management is over-optimization. Careful management frees up cash for other priorities, but a too-tight focus can leave operations hobbled by a lack of funds or inventory. Fine-tuning working capital strategies is not an excuse to defund departments or necessary operations; instead, it is a chance to improve financial outcomes for the entire business.
Historically, working capital management is a short-term outlook, considering only current assets and liabilities. A wider perspective is also required to fully understand a company’s ongoing financial health. But putting an effective working capital strategy in place creates room for sustainable growth, balancing efficiency with resilience and giving companies the ability to strategically use their freed-up cash on acquisitions, capital investments or R&D.
Get Expert Capital Management Guidance
Optimizing current assets and liabilities increases cash flow and strategically positions a company to grow. Reliably managing working capital allows a company to fund growth, weather economic uncertainties and outperform its competitors. Sound working capital strategies build a business’s capacity for resilience and can lead directly to bottom line improvement.
If it’s time to assess your company’s current working capital position and performance, Paro can help. Our fractional CFO experts can put your strategy into action, increasing liquidity and streamlining your metrics.
