How can SMEs efficiently manage their working capital?
Simon Frimpong BMS,MSc
Digital content creator l Business Manager l Sales Coach l Project Manager l Business Consultant l Data Analyst l Brand Activation Manager l EDGE Dialogue
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On the second episode of 'EDGE Dialogue', February 24, 2024, we had an insightful session with Collins Apau-Twum on the topic: How can SMEs efficiently manage their working capital?
Key takeaways and valuable insights
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Working capital is a financial metric that reflects a company's operational liquidity and short-term financial health.
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What are your working capital requirements as a SME? Ensure you have enough cash to cover supplier payments and daily business operations.
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Key Components of Working Capital
Current Assets
?? Inventory
?? Cash and Cash equivalents
?? Accounts receivable
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Current liabilities
?? Trade payables
?? Other creditors
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Formula
Working Capital =?Current Assets?–?Current Liabilities
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As a SME, how can you efficiently manage your working capital?
1.?The most liquid of your current assets are your cash on hand, cash in the bank, and cash equivalents (short-term investments that can be converted into cash quickly). Be slow to let cash out and quick to collect cash.
2.?Maintain consistent cash flow by keeping adequate levels of inventory so that cash is not trapped in inventory.
3.?Negotiate with trade partners to pay their cash early in exchange for early settlement discounts to show up your cash flows; conversely, negotiate with suppliers for longer payment terms to shore up your cash balances.
4. Trade Payables is your lifeline as a SME. Maintaining positive supplier relationships is critical to the survival of SME businesses. Statutory account payables should be paid when they are due.
5.?Before you invest in CAPEX, ensure that the assets you are investing in the interim can pay for itself or generate cash flows. Do not use your working capital to fund CAPEX.
6. Maintain a shorter operating cycle by converting inventory and receivables to cash faster. The shorter the operating cycle, the more efficient your working capital.
7.?Keep track of and know who owes you money.
8. Implement a strong credit policy: Give customers shorter credit terms. As an SME, do not provide your trade partners with the same credit days that your supplier does. Alternatively, do not extend credit beyond what your supplier has given you.
9.?Inventory Management- Keep an appropriate amount of inventory on hand. Know your minimum order and reorder quantities. Slow-moving products will impact on your cash flow. Holding a large inventory result in high interest costs because you rely on an overdraft to pay for inventory you have yet to sell.
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Financial Ratios to help evaluate the health of your business.
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1.?Current Ratio = Current Assets / Current Liabilities.??? ???????????????????????????
? A Ratio of >= 1 means a business has enough current assets to meet up all their short-term obligations. On the other hand, a Ratio of < 1 means a business cannot meet all its short-term financial obligations. A higher ratio of 1.5 means the business is not efficiently using its assets to generate revenue.
2.?Quick Ratio = [Current Assets - Inventory]/ Current Liabilities
The quick ratio is a more stringent measure of liquidity as it excludes inventory, which may take time to convert into cash. A ratio above 1 implies that a company can meet its short-term obligations without relying on the sale of inventory.
3. Debt to Revenue Ratio- Trade debt / Revenue
A Ratio of more than 15% means a lot of revenue generated sits in receivables ( Trade debt).You need to intensify your cash collections.