8. Working Capital Management

Working capital management (WCM) is a business strategy that enables companies to make the best use of their current assets while maintaining enough cash flow to meet their short-term goals and obligations. Companies can free up cash that would otherwise be trapped on their balance sheets by improving how they manage working capital. As a result, they may be able to reduce their reliance on external borrowing, expand their businesses, fund mergers, and acquisitions, or invest in research and development.

Working capital is critical to the health of any business, and improving your working capital position can boost your company's operational efficiency, but managing it effectively is a balancing act. Companies must have enough cash on hand to cover both anticipated and unanticipated costs, while also making the best use of available funds to fuel growth. This is accomplished through effective management of accounts payable, receivable, inventory, and cash.

Calculating Working Capital:

Working capital is defined in financial management as current assets minus current liabilities, which can be calculated by subtracting current liabilities from current assets. As a result, the working capital formula is as follows:

Cash and accounts receivable are examples of current assets, while accounts payable are examples of current liabilities.

Other crucial working capital metrics are:

1. Working capital ratio - a liquidity measure and another way of looking at current working capital that is calculated by dividing total current assets by total current liabilities.
2. Days Payables Outstanding (DPO) - the average number of days it takes for a company to pay its suppliers.
3. Days Inventory Outstanding (DIO) - the average number of days it takes for a company to sell its inventory.
4. The Cash Conversion Cycle (CCC) - it is the average time it takes for a company to convert its inventory investment into cash.

Cash Conversion Cycle is calculated as follows:

CCC = DIO + DSO – DPO

The lower a company's CCC, the faster it converts cash to inventory and back to cash. Companies can shorten their cash conversion cycle in three ways: by asking customers to pay faster (reducing DSO), by extending payment terms to suppliers (increasing DPO), or by shortening the time inventory is held (reducing DIO).

Working capital management that works:

Accelerating the CCC can improve a company's working capital position, but it may have unintended consequences. Reduced inventory levels, for example, may have a negative impact on your ability to fulfill orders.

In the case of DPO, your accounts payable are also your suppliers' accounts receivable, so paying suppliers later may improve your own working capital at the expense of your suppliers' working capital. This could harm your relationships with suppliers and make it difficult for cash-strapped suppliers to fulfill your orders on time.

Therefore, effective working capital management entails taking steps to improve the company's working capital position while avoiding negative consequences elsewhere in your supply chain. This could include lowering DSO by implementing more efficient invoicing processes, allowing customers to receive invoices sooner. Alternatively, it could imply implementing an early payment program that allows your suppliers to receive payment sooner than they would otherwise.

WCM solutions:

Companies can use a variety of solutions to help them manage their working capital effectively, both internally and with their suppliers. These are some examples:

• E-Invoicing: Companies can benefit from electronic invoice submission in terms of working capital. By streamlining the invoicing process, you can reduce the risk of errors, automate manual processes, and ensure that your customers receive your invoices as soon as possible - which could lead to you getting paid sooner. Companies can use electronic invoice submission methods to automatically convert purchase orders into invoices or to submit large volumes of invoices using system-to-system integration.
• Inventory control: Smart inventory management solution implementations can help to improve your balance sheet or working capital position by shortening lead times, ensuring access to safety stock, and making the inventory process more transparent in general.
• Supply Chain Financing: Supply chain finance, also known as reverse factoring, is a method for buyers to offer suppliers early payment through one or more third-party funders. Suppliers can improve their DSO by getting paid sooner and at a lower cost of funding, while buyers can preserve their own working capital by paying on time.
• Dynamic Discounting: Another solution that buyers can use to provide early payment to suppliers is dynamic discounting, but this time there is no external funder because the program is funded by the buyer through early payment discounts. This, like supply chain finance, allows suppliers to reduce their DSO. Furthermore, it enables buyers to earn an appealing risk-free return on their excess cash.
• Flexible Funding Solutions: Flexible funding providers like C2FO may allow buyers to seamlessly transition between supply chain finance and dynamic discounting models, allowing businesses to adapt to their varying working capital needs while continuing to support their suppliers.

C2FO offers a wide range of funding solutions, all on a single, easy-to-use platform. (link to C2FO's webpage)