How To Improve Working Capital Management

by : bizavings

"Cash is the lifeblood of business" is an often repeated maxim amongst financial managers. Working capital management refers to the management of current or short-term assets and short-term liabilities. Components of short-term assets include inventories, loans and advances, debtors, investments and cash and bank balances. Short-term liabilities include creditors, trade advances, borrowings and provisions. The major emphasis is, however, on short-term assets, since short-term liabilities arise in the context of short-term assets. It is important that companies minimize risk by prudent working capital management.

What Affects Working Capital Management

1. Organizations are generally focused on cash, accounts payable, and supply chain issues. However, external issues like the legal and business environment, or internal mechanisms like organization structure and information systems, can significantly impact working capital.

2. Owing to market pressures, companies are led to paying a lot of attention to producing good quarterly results quarter after quarter. Undue focus on this may sometimes produce a flattering but inaccurate snapshot of working capital performance. This also happens in companies that have a marked seasonality of operations with working capital requirements varying widely from quarter to quarter.

Measures to Improve Working Capital Management

1. The essence of effective working capital management is proper cash flow forecasting. This should take into account the impact of unforeseen events, market cycles, loss of a prime customer, and actions by competitors. The effect of unforeseen demands on working capital should be factored in.

2. It pays to have contingency plans to tide over unexpected events. While market leaders can manage uncertainty better, other companies must have risk management procedures. These must be based on an objective and realistic view of the role of working capital.

3. Addressing the issue of working capital on a corporate-wide basis has certain advantages. Cash generated at one location can well be utilized at another. For this to happen, information access, efficient banking channels, good linkages between production and billing, internal systems to move cash and good treasury practices should be in place.

4. An innovative approach, combining operational and financial skills and an all encompassing view of the company's operations will help in identifying and implementing strategies that generate short term cash. This can be achieved by having the right set of executives who are responsible for setting targets and performance levels. They are then held accountable for delivering. They are also encouraged to be enterprising and to act as change agents.

5. Effective dispute management procedures in relation to customers will go along way in freeing up cash otherwise locked in due to disputes. It will also improve customer service and free up time for legitimate activities like sales, order entry, and cash collection. Overall, efficiency will increase due to reduced operating costs.

6. Collaborating with your customers instead of being focused only on your own operations will also yield good results. If feasible, helping them to plan their inventory requirements efficiently to match your production with their consumption will help reduce inventory levels. This can be done with suppliers also.

Working capital management is an important yardstick to measure a company's operational and financial efficiency. This aspect must form part of the company's strategic and operational thinking. Efforts should constantly be made to improve the working capital position. This will yield greater efficiency and improve customer satisfaction.