“Cash is king” is a phrase often used to underline the importance of effective working capital management in a business. In an uncertain economic climate companies experience consistent financial pressure, so cash flow management is more relevant than ever. Let’s face it — without the right amount of cash, your business will inevitably run into distress, and, if not corrected, into failure.
According to the accountants, PWC, in their 2015 Annual Global Working Capital Survey “Bridging the Gap”, the cash opportunity from improving working capital to UK industrial manufacturers could be as high as £9bn!
Managing working capital clearly needs to be on the agenda of UK business but cash flow concepts and terms need first to be understood.
Working capital is a measure of the investment required to finance the ongoing operations of the business. It is defined as “current assets less current liabilities”. Both current assets and current liabilities are short term values so working capital is a measure of a company’s efficiency and short-term financial health. A healthy business should have positive working capital. If you have fewer current assets than current liabilities there is a higher chance that the business will not be able to pay off its short term debts as they fall due. Ultimately, if you are unable to pay your creditors, the business could go into liquidation.
The working capital ratio (current assets/current liabilities) indicates whether a company has enough short term assets to cover its short term debt. It may differ from sector to sector but a guideline is that the working capital ratio should be between 1.2 and 2.0.
The components of working capital are:
Current Assets = cash + debtors/accounts receivable + work in progress + stock
Current Liabilities = creditors/accounts payable + short term debt + other expenses due within one year
SME owners and managers will want to ensure that cash flow is managed closely. Here are some key levers to improve the working capital position of the business.
1. Know your costs and purchase wisely
All business expenses involve a purchase transaction, at least initially. It is important to buy wisely and make the most of modern purchasing techniques to ensure that the business is receiving value for money. This means buying at the right price and quality level and on the right terms. Thoughtful business spending helps you save small amounts at every transaction and this quickly adds up.
2. Operate with efficient processes
The working capital cycle can be reduced in most businesses by removing those non-value added activities and shortening the time it takes to process information and orders through the business. The quicker the business can deliver high quality services and products to the customer, the quicker it can invoice and be paid.
3. Invoice promptly and accurately
The working capital cycle of a business is the time it takes from receiving the order to depositing the payment for that order into the bank. For some consumer-facing businesses this is immediate or quite short, for most businesses working on commercial terms with customers they may have to wait 30 to 120 days from the date of the invoice. So agree payment terms you can handle with your customer and ensure invoices are raised promptly and accurately once the product or service is delivered.
4. Grow within your means
Most company management teams desire to grow their business and each company has a viable rate of growth that can be supported by internally generated cash flow. More accelerated growth, if achievable, could be funded through access to alternative funding providers, such as YesGrowth. Either way, growth needs to be carefully managed from a cash perspective as even successful companies can run out of cash.
5. Know what funding is available
There was a time when the only source of funding available to a small and medium sized business was the local bank who would provide overdraft and various types of lending facilities. The world has changed considerably since 2008-9 and a new set of alternative finance providers has emerged offering flexible, rapid and innovative financing approaches to support UK business. Click here for the YesGrowth Guide to Alternative Finance.