12 May How to Shape Up Your Working Capital
Working capital — current assets minus current liabilities — is a common measure of liquidity. High liquidity generally equates with low risk, but excessive amounts of cash tied up in working capital may detract from growth opportunities and other spending options, such as expanding to new markets, buying equipment, and paying down debt. Here are some recent working capital trends and tips for keeping your working capital in shape.
Working capital management among U.S. companies has been relatively flat over the last four years, excluding the performance of oil and gas companies, according to the 2016 U.S. Working Capital Survey published by consulting firm REL and CFO magazine. The overall results were skewed somewhat because oil and gas companies increased their inventory reserves to take advantage of low oil prices, thereby driving up working capital balances for that industry.
The study estimates that, if all of the 1,000 companies surveyed managed working capital as efficiently as do the companies in the top quartile of their respective industries, more than $1 trillion of cash would be freed up from receivables, inventory, and payables.
Rather than improve working capital efficiency, however, many companies have chosen to raise cash with low interest rate debt. Companies in the survey currently carry roughly $4.86 trillion in debt; more than double the level in 2008. As the Federal Reserve Bank increases rates, companies will likely look for ways to manage working capital better.
How can your company decrease the amount of cash that is tied up in working capital? Best practices vary from industry to industry. Here are three effective exercises for improving working capital:
- Expedite collections – possible solutions for converting receivables into cash include tighter credit policies, early bird discounts, collection-based sales compensation, and in-house collection personnel. Companies also can evaluate administrative processes — including invoice preparation, dispute resolution, and deposits — to eliminate inefficiencies in the collection cycle.
- Trim inventory – this account carries many hidden costs, including storage, obsolescence, insurance, and security. Consider using computerized inventory systems to help predict demand, enable data sharing up and down the supply chain, and more quickly reveal variability from theft.
- Postpone payables – by deferring vendor payments, your company can increase cash on hand. However, be careful: Delaying payments for too long can compromise a firm’s credit standing or result in forgone early bird discounts.
From Analysis to Action
No magic formula exists for reducing working capital, but continuous improvement is essential. We can help train you on how to evaluate working capital accounts, identify strengths and weaknesses, and find ways to decrease working capital without compromising supply chain relationships.