Investing enough, but no more, in working capital at any point is good business practice
During periods of growth, working capital investment is open the biggest limiting factor to growth and therefore can be very co stly in lost proﬁts
Reducing the business investment requirement increases the eﬃciency of your business and improves the return on investment for owners
The theory is straight forward
Putting it into practice for a business with a range of clients and suppliers, stock requirements and other challenges can be tricky. Usually it is surprising how much the business can control, and therefore is able to alter working capital
Practical approaches to reducing working capital:
Understanding your stock requirements and how quickly items can be replaced is important before you make any changes. This should be done on a product line or individual product basis for best results.
Consider for each product:
- Lead time for replacement of stock items (order, manufacturing and delivery cycle)
- Volume of product sold per week/month vs current stock levels.
- The volatility of sales (off promotion) and therefore understand what safety margins are needed
- Any promotional activity (price promotions or marketing activity) that is likely to change the stock throughput.
When you have analysed the above you should be able to work out exactly how much stock should be held for each product at any given time. Add a margin of safety that you are comfortable with.
Compare this to your current stock holding and make changes accordingly. If you want to be cautious (recommended), make several step changes towards the levels outlined from your analysis and check for any unexpected results
Short to medium term, three areas need to be reviewed:
- Invoicing process i.e. how quickly are invoices issued to customers
- The quality of the invoices (high quality = less queries) and how quickly queried invoices are dealt with to the satisfaction of the customer
- How good are the credit control team and what processes to they follow.
Invoicing process – The key goal is to get an accurate invoice in the format the customer requires to the customer as quickly as possible.
Firstly, consider if automation of part or all of the invoicing process is a sensible and cost effective option for your business. The higher the invoice volumes the more likely this will be the case. As well as cost, accuracy and speed are also very important benefits.
Break down the whole invoicing process into information flows and tasks. Are there any bottle necks or areas that have a lot of manual intervention? Can these processes be redesigned with issues reduced or removed? It is worth spending some time on the overall process design.
Try to ensure that as much of the invoice process is consistent i.e. the same tasks performed in the same way.
Would your customer consider a different invoicing approach that benefits both parties? Are you able to demonstrate administration costs savings or resolution of long standing issues for the customer as well?
Invoicing Quality – If you have current invoice quality issues, find out why they are arising. Typical areas might include:
Internal to finance team:
a different process is applied to each customer (i.e. variety of process), poor tools for staff, lots of manual intervention, incorrect setup of customers, poor quality staff (attention to detail), lack of training
External to finance team:
poor quality input information, missing information, constantly changing information, last minute information or quick turnaround demands
Addressing the problem areas are then essential. Time invested in this area will reduce time spent on invoice queries and credit control (which can be significant).
Credit Control – The credit control team’s approach to collecting cash should be systematic and process driven for best results. Different businesses have different approaches. These depend on volume and value of invoices, number of and relationship with customers, products or service and similar.
A simple approach might be:
- Call the new customer and ask to be walked through the payment process and document the process.
- Call customer x days after issuing invoice. Ensure the customer received the invoice and there are no queries.
- Use finance system generated aged debt reporting based on due dates to monitor when payment should be received and what action need to be taken by the team.
- Call customer y weeks prior to payment due date. Find out if the invoice: has been approved for payment, has been included on the next payment run, expected payment date.
- For all overdue debt, repeat step 3 on a daily/weekly/other basis.
- Devise and consistently follow a bad debt process for debt more than x weeks/months overdue.
Ensure that the team is well trained and know what actions are need and why. The team are a really important touch point with your customers so how they communicate with customers is also really important and reflects on your business branding
Long term, understanding what credit terms are being offered to customers in practice and potentially ensure these are changed to pre-defined ranges. This is essential to impacting the investment in debtors. We suggest that you alter the sales teams commission structures to include credit terms agreed with customers as part of their metrics
The aim is to increase payment terms as much as possible without impacting pricing/service/product. There is usually a balance between pushing out payments to suppliers and getting the best pricing/service/product.
Do not treat all suppliers equally. Segment your suppliers into partners, important suppliers, commodity suppliers (or a suitable grouping for your business). Negotiate the best terms for your business with your suppliers. For commodity suppliers, change or consolidate as needed.
As with debtors, we suggest that you approach paying suppliers in a systematic process orientated way, using system generated aged creditor reports based on due date. This ensures consistency which generates confidence and is professional in approach. The first thing suppliers want is to be paid, second ideally to terms or as quick as possible.
For an free initial discussion on how to reduce your working capital, contact us.