Know your operating cycles and you’ll find working capital easier to manage

Managing the working capital of a business tends to be a balancing act that requires a deft touch in order for the company to operate smoothly, says Michael Hengl, senior vice president and business line manager for Capital Finance at Bridge Bank.

“Working capital tends to be comprised by inventory, cash and receivables,” Hengl says. “Too much or too little of any of those categories can make it difficult to be a profitable company.”

If you have too much cash sitting on your balance sheet, that’s an opportunity cost, he says.

“You’re not investing that cash in a higher yield,” Hengl says. “At the same time, if you have too much inventory, that’s cash that is tied up and you risk inventory obsolescence. You risk not being able to sell the inventory in time and you put a strain on your liquidity that could impede your ability to meet financial obligations.”

When you understand your operating cycle and how money is spent and earned in your business, you are better able to retain control of your valuable working capital.

Smart Business spoke with Hengl about what strong companies do to effectively manage their financial cycles.

How do companies typically get into trouble managing their working capital?
Rapidly growing companies are often susceptible to cash flow concerns because they invest heavily in inventory, only to watch the economy take a downturn that leaves them with a warehouse full of unsold product.

You may also choose to be more conservative with your inventory, but if you cut it too close, you risk missing out on sales when you can’t keep up with demand.

But it’s often that strong growth, which is obviously what every company wants, that can really put a strain on working capital.

A company will say, ‘We’re selling more than we ever have. Why is there such a strain on cash in our company?’ The problem arises when you become too focused on your income statement and your revenue and profits. You also need to look at the balance sheet items and your assets and liabilities. You need to have a balance.

What are some traits common to well-managed companies?
You need to have a strong understanding of your company’s operating cycle from the point that you make an investment or buy inventory to the point that it gets converted back into cash. You need to be knowledgeable about the components and decision points within that cycle.

Work closely with your inventory managers or your product managers to determine how much product is needed. Spend time with accounts receivable and talk about credit terms that are available to clients.

You don’t want to be overly generous where you potentially end up with bad debt and extended receivables. Nor do you want terms to be restrictive to the point where you lose the opportunity to make a sale.

These types of companies tend to be very strong at predicting cash flow and at setting up contingency plans if a client doesn’t pay on time. Do you have a line of credit in place to handle the unexpected? Can you defer a payment to a vendor?

If your company struggles to collect receivables, look for ways to get your clients on a regular schedule. If you’re going to grant extended terms, try to get a concession out of it. Tell the client, ‘We’ll grant you another 30 days, but can you pay 25 percent of it today?’ There are many ways to work with a client.

How can a bank help?
Sit down with a bank’s treasury management department and look at tools that might speed up bill collections or shorten the cash cycle through the use of a lockbox, remote deposit capture or electronic banking.

A bank can also help you identify possible remedies in your reporting or poke holes in faulty assumptions you may have made about your business. Your bank has a vested interest in seeing your business grow and succeed.

Another thing to keep in mind is when you have a bank audit. Don’t be afraid to ask about the results. There may be findings that can help you improve your processes. ●

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