Improve Cash Flow with Working Capital Management

What Is Working Capital Management

Working capital management refers to the strategic management of a company’s short-term assets and liabilities to ensure efficient operation and financial stability. It involves overseeing the cash, inventory, accounts receivable, and accounts payable to optimize liquidity and maximize profitability.

Effective working capital management aims to strike a balance between liquidity and profitability by minimizing the amount of capital tied up in non-productive assets. At the same time, intelligent automation ensures the smooth operation of day-to-day business activities.

Building Blocks of Working Capital Management

Cash Management

Managing cash inflows and outflows to maintain adequate liquidity for daily operations, investments, and unforeseen expenses. This involves optimizing cash flow forecasting, monitoring cash balances, and implementing cash conservation strategies.

Inventory Management

Optimizing inventory levels to meet customer demand while minimizing carrying costs, stockouts, and obsolete inventory. This entails implementing inventory control techniques, such as just-in-time (JIT) inventory management, to improve efficiency and reduce inventory holding costs.

Accounts Receivable Management

Managing accounts receivable to accelerate cash inflows and reduce the risk of bad debts. This includes establishing credit policies, monitoring customer creditworthiness, and implementing effective invoicing and collection processes to shorten the cash conversion cycle.

Accounts Payable Management

Managing accounts payable to optimize cash outflows and maintain favorable supplier relationships. This involves negotiating favorable payment terms with suppliers, optimizing payment schedules, and leveraging discounts for early payments to conserve cash and improve working capital efficiency.

As you can see, effective working capital management is essential for ensuring the financial health and sustainability of a business. By managing short-term assets and liabilities, you can improve liquidity, reduce financial risk, and enhance profitability in both the short and long term.

The Importance of Working Capital Management

As we already know, working capital refers to the current assets and liabilities of a company. In order for a company to operate efficiently, its working capital must be monitored and managed effectively. In a fast-paced market environment, with heavy competition and new products in the market every day, managing cash and maintaining sufficient liquidity becomes difficult.

For companies to manage their short-term liabilities and long-term investments, they have sufficient cash in hand. A company must monitor its current assets and liabilities regularly and be able to make timely reconciliations and debt payments to ensure healthy liquidity.

Sound working capital management practices go a long way in ensuring a healthy build-up of cash reserves and low debt obligations for the long-term.

Working Capital Management and Cash Flow

The main aim of working capital management is to maintain sufficient cash flows at all times. At any time, the working capital for a company is calculated as the net value of its current assets minus its current liabilities.

Extra cash, accounts receivables, investments, and inventory, all account for current assets. On the other hand, current liabilities include pending debt payments and operational expenses (opex).

Maintaining a positive working capital at all times is difficult but a good way to manage healthy cash flows is by closely monitoring accounts receivables and accounts payables.

READ MORE: Cash Flow Statement: Definition, Template, Examples

Real-Life Example of Balance Between Working Capital and Cash Flow

For many companies, the onset of more sales, although indicative of growing revenues, actually means incurring more expenses in terms of operating and manpower costs.That’s why the profit margins for growing companies are low as they need to pay for the running or overhead costs corresponding to an increase in production and sales.

Also, if receivables are delayed, there is a delay in cash inflows, making it difficult to pay-off debt and invest in future opportunities.

Improving Cash Flow Through Working Capital Document Management

There is hidden cash in document-dependent processes within accounts payable and accounts receivable that can be tapped into through working capital document optimization. There are several perks to digitally transforming document-dependent processes that both small and mid-sized companies (SMBs), as well as large corporations, can take advantage of to ensure consistent financing and cash inflows in the long-term. These are typical running costs that can be controlled and monitored for efficiency in working capital management:

Accelerating Invoice & Order Processing

A major portion of accounts payable operations goes into performing tons of invoice data entry and data validation work. Slow invoice processing can delay payments to vendors, and you could end up paying late payment fees. Delayed vendor invoicing, payments processing, and reconciliations can lead to a slow build up of debt, not ideal for maintaining a positive working capital.

To reduce bad debt, businesses must accelerate invoice processing and ensure they pay vendors on time. Timely debt reconciliations will also increase vendors’ trust in you, enabling you to purchase raw materials and goods from vendors at competitive prices.

Maintaining your payables at a minimum will help you get clarity on the pending liabilities that must be reconciled and prepare you to handle your finances accordingly.

Improving Cash Flow with Order Processing

Order processing, like invoices, is another highly document-intensive, time-consuming manual process. A sales order is generated every time a customer places an order with your company. Processing orders on time will help you deliver and fulfill customer demand on time, but most importantly, by accelerating sales order processing, you will be able to prompt the customer to pay you for the goods and services provided without delays.

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Better Cash Flow With AP and AR Automation

Intelligent process automation lowers the dependence on manpower to perform mundane, repetitive tasks in accounts payable and accounts receivable. Typical paperwork in AP/AR like invoice processing and customer sales order processing involve a lot of data entry and document processing work.

Apart from the savings achieved with early payments and faster fulfillments, optimizing and accelerating these processes will help companies lower the burden on the employees to implement these repetitive tasks and have them focus on more strategic tasks.

Reducing the number of employees required to implement document processing in AP/AR will help lower the costs of hiring them, and subsequently free up cash.

Mobilizing Inventory for Improving Cash Flow

Inventory sitting in your warehouse is a lost opportunity for sales, revenues, and business mobility. Also, the longer it takes to dispose or sell off inventory, the longer you’ll have to pay for the real estate and management to maintain that inventory. These are lost dollars that could hurt your working capital greatly.

Data on inventory stock and logistics is very important to proactively manage inventory flows. This data is best cultivated, accessed and processed using technology.

Intelligent Processing Automation: Improve Cash Flow and Optimize Working Capital

Intelligent process automation software removes a lot of the inefficiencies and delays in processing documents and capturing data necessary for optimal cash flow. The software utilizes digital transformation technologies like:

• AI and machine learning
• Robotic process automation
• Intelligent data capture
• Powerful recognition software like OCR

To capture, extract, validate, and verify data from transaction and source documents.

As a result, companies capture data and transaction information right at the source where it is generated like, say, a sales order received by a retail facility. This data, when digitized and uploaded into a suitable workflow automation solution, makes it centralized, and highly accessible and visible to all concerned parties.

For instance, a new sales order at a retail facility may trigger the concerned personnel at an inventory location to source, package, and ship the order to the retail outlet or directly to the end customer, depending on the logistics drawn out by a company.

DISCOVER MORE: Accounts Payable Turnover Ratio: Formula, Understanding, Uses

Intelligent process automation captures business and transaction data at the source, processes it to make it useful to concerned parties along a process chain like say, an inventory management unit, and ‘repurposes’ that data for reporting and analytics, for example, understanding the current state of working capital and the way forward for businesses.

Working Capital Management and Cash Flow: Key Terms to Remember

What Is Working Capital Definition?

This is the difference between a company’s current assets (such as cash, accounts receivable, and inventories) and current liabilities (such as accounts payable and short-term debt). It represents the short-term liquidity available to a business.

What Are Current Assets and Liabilities ?

Assets that are expected to be converted into cash or used up within one year or within the business’s operating cycle, whichever is longer. Examples include cash, accounts receivable, and inventory. Current liabilities are obligations that are due to be settled within one year or within the operating cycle of the business. Examples include accounts payable, short-term loans, and accrued expenses.

What Is Cash Conversion Cycle (CCC)?

A metric that shows the time it takes for a company to convert its investments in inventory and other resources into cash flows from sales. It is calculated as the sum of the inventory period, the receivables period, and the payables period.

Inventory Management: The process of ordering, storing, and using a company’s inventory. This includes managing raw materials, components, and finished products, as well as warehousing and processing such items.

Can You Define Cash Flow?

This is the net amount of cash being transferred into and out of a business. Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

What Are the Types of Cash Flow?

Operating Cash Flow (OCF) is cash generated from a company’s normal business operations. It indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations. Free Cash Flow (FCF) is the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. It is calculated as operating cash flow minus capital expenditures (CAPEX).

What Is a Cash Flow Statement?

This is a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given period.

What Are Operating and Investing Activities?

These are activities that relate to the primary revenue-generating operations of a business. Examples include cash receipts from sales of goods and services, cash payments to suppliers, and cash payments for operating expenses.

In comparison, investing activities related to the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples include the purchase or sale of property, plant, and equipment, and investment securities.

Final Thoughts: Breathe Easy with a Healthy Cash Flow: The Power of Working Capital Management

Working capital management isn’t just about crunching numbers; it’s about breathing life into your business. By implementing the strategies outlined in this blog post, you can achieve a healthy cash flow that empowers you to:

• Take advantage of growth opportunities: Invest in innovation, expand your market reach, and seize new opportunities.
• Maintain financial stability: Weather economic storms and unforeseen circumstances with confidence.
• Improve supplier relationships: Timely payments foster stronger partnerships with your vendors.
• Enhance investor confidence: A healthy cash flow demonstrates financial strength and attracts potential investors.
• Gain peace of mind: Knowing your business has a healthy financial foundation allows you to focus on strategic initiatives and long-term success.

Remember, working capital management is an ongoing process. Regularly monitor your key metrics, refine your strategies, and leverage technology to automate tasks. By taking control of your working capital, you lay the foundation for financial stability and sustainable growth for your business. Start optimizing your cash flow today and breathe easy knowing your business is on the path to financial freedom!