8 Proven Ways to Improve Working Capital Management Today

Understanding Working Capital: What It Is and Why It Matters

Working capital measures a company’s ability to meet its short-term financial obligations. It is the lifeblood of any business, and it is essential to ensure that there is enough cash on hand to cover immediate expenses.

Working capital is calculated by subtracting current liabilities from current assets. Current assets include cash, accounts receivable, inventory, and other assets that can be easily converted into cash. Current liabilities, on the other hand, include accounts payable, short-term loans, and other debts that are due within a year.

The net working capital is another important metric that measures the liquidity of a company. It is calculated by subtracting current liabilities from current assets, just like working capital. The net working capital provides a more accurate picture of a company’s financial health, as it takes into account the company’s short-term obligations.

Working capital influences many parts of a business, such as paying employees and suppliers and planning for long-term growth. Experiencing cash shortages can contribute to increased stress levels and create obstacles for managing business operations. In a nutshell, working capital is the cash a company has in hand to pay for immediate and short-term obligations.

Working Capital Optimization: Analyzing for Gaps and Opportunities

Analyzing working capital is critical to identifying gaps and opportunities for improvement. By measuring key performance ratios, businesses can gain insights into their liquidity and profitability and make informed decisions about how to manage their working capital effectively. Here are the three key ratios used to analyze working capital:

1. Working Capital Ratio: 

This ratio measures a company’s ability to meet its short-term financial obligations. It is calculated by dividing current assets by current liabilities. A high working capital ratio indicates that a company has enough liquid assets to cover its short-term obligations, while a low working capital ratio may suggest that a company is facing liquidity issues.

2. Inventory Turnover Ratio: 

This ratio measures how quickly a company’s inventory is sold and replaced. A high inventory turnover ratio indicates that a company is efficiently managing its inventory, while a low inventory turnover ratio may suggest that a company is holding too much inventory or facing difficulties in selling its products.

3. Collection Ratio: 

This ratio measures how quickly a company collects its accounts receivable. A high collection ratio indicates that a company is efficiently collecting its receivables, while a low collection ratio may suggest that a company is experiencing difficulties in collecting payments from its customers.

By analyzing these ratios, businesses can identify gaps and opportunities for improvement in their working capital management. For example, a company with a low working capital ratio may need to take steps to improve its liquidity by increasing its cash reserves or reducing its short-term debt. Similarly, a company with a low collection ratio may need to implement more efficient billing and collection processes to improve its cash flow.

Common Factors Contributing to Low Working Capital in Companies

Low working capital is a significant problem that many companies face, and it can be caused by a variety of factors. Here are some common factors that contribute to low working capital in companies:

1. Poor Cash Flow Forecasting: 

Inaccurate forecasting of cash flows can lead to the maintenance of large cash buffers, resulting in lower business investment or higher borrowing costs. Inaccurate cash forecasts can also negatively impact the forecast team’s internal credibility, leading to a lack of confidence in the company’s financial management.

2. Manual Operations: 

Many businesses still rely on manual processes for their day-to-day operations, such as gathering data from different sources, collaborating between departments, and using spreadsheets to consolidate data. These manual tasks are time-consuming, error-prone, and lead to low cash flow visibility, which can result in poor financial decision-making.

3. Lack of Systems to Track Receivables: 

Companies that do not have suitable systems to analyze customer payment patterns are unable to track and manage their receivables effectively. This leads to a high DSO (Days Sales Outstanding) and impacts a firm’s reputation, as customers may view the company as unprofessional or unreliable.

4. Dead-On-Arrival Reports: 

Manual methods often result in “dead-on-arrival” reports, which are reports that are outdated or irrelevant by the time they are generated. This results in high turnaround time and low bandwidth, obstructing timely decision-making and preventing teams from focusing on high-value tasks.

By identifying and addressing these common factors, companies can take steps towards working capital improvement. In the next section, we will explore some strategies for boosting working capital and improving financial performance.

8 Best Practices to Improve Working Capital Management

Boosting working capital is crucial for businesses to maintain their financial health and achieve long-term success. By implementing effective working capital management strategies, companies can optimize cash flow and minimize the impact of managing cash shortages. Here are eight strategies that can help businesses improve working capital management:

1. Improve Cash Visibility: 

Companies can improve their cash visibility by automating their cash forecasting processes. This creates a single source of truth by gathering data from different systems and provides a more accurate view of their cash flows.

2. Improve Forecasting Accuracy: 

Incorporating AI and machine learning technologies can help companies improve their forecasting accuracy. This allows treasury teams to shift their focus from manual tasks to strategic duties like team and task management, reporting, and decision-making.

3. Improve A/R Management: 

Accurately forecasting accounts receivable is critical for managing working capital. By automating data capturing, accurately forecasting payment dates, and identifying customer behavior variables, companies can improve their A/R cash forecasting accuracy.

4. Run Scenario Analysis: 

Cash flow forecasting software allows treasury teams to track various scenarios and stress-test potential situations, identifying their potential impact on cash flows and coming up with solutions to potential financial problems.

5. Perform Variance Analysis: 

Most companies neglect variance analysis due to bandwidth limitations. So, their forecasts are usually inaccurate. Hence, they should perform frequent variance analysis. Regular variance analysis helps companies understand deviations between forecasts and actuals, identify variance drivers, and make adjustments to their forecasts to improve forecast accuracy.

6. Cut Unnecessary Expenses: 

To overcome shortage of working capital, cash-deficit companies can reduce expenses by cutting production and supply costs, reducing inventory levels, automating tasks, using cloud storage, tracking tax write-offs, and avoiding interest fees.

7. Shorten Operating Cycles: 

Shorter operating cycles suggest that a company has enough cash to maintain operations. It also means that companies can recover investments and meet their obligations. If a company’s operating cycle is very long, it can cause cash flow issues. Companies can shorten their operating cycles by speeding up the sale of their inventory, reducing the time needed to collect receivables, and extending the time to disburse payables.

8. Track Balance in the Revolver: 

Revolving credit is good for companies that have unanticipated expenses. Cash-deficit businesses can overdraw from their credit facility based on the revolver balance. Companies should track their revolver balance by keeping track of the available credit, using a debt module to monitor borrowing activity, and making short-term forecasts to avoid overborrowing.

By implementing these strategies, businesses can improve their working capital management and achieve their financial goals. In the next section, we will explore how HighRadius’ capital forecasting solutions can help companies achieve their working capital goals.

Maximizing Working Capital Efficiency through Capital Forecasting Solutions

A working capital solution for forecasting working capital helps a business by:

How can HighRadius Cash Forecasting Solution Help Manage Working Capital?

HighRadius’ cash forecasting solution is a powerful tool that can help companies manage their working capital more effectively. By using actual data from the past and analyzing disparities between predictions and actuals, this software can generate accurate cash forecasts and improve financial decision-making.

One of the key benefits of HighRadius’ cash forecasting solution is its ability to integrate with ERP systems, bank portals, and TMS, which improves visibility and reduces errors. The software also provides real-time data, enabling accurate reporting and decision-making.

By using this solution, companies can make confident working capital decisions, reduce borrowing costs, and increase investment returns. Additionally, the software can forecast for all cash flow categories, including accounts receivable and accounts payable, with an accuracy rate of 95%.

If your company is facing challenges with cash flow management and working capital, HighRadius’ cash forecasting solution can help. Schedule a demo today to learn more about how this powerful tool can help your business achieve its financial goals and maintain its financial health. Don’t miss out on the opportunity to improve your working capital management and achieve long-term success.

FAQs on Working Capital Management

1. What causes cash shortage in a company?

Cash shortage in a company can be caused by various factors, including poor budgeting, slow sales, excessive debt, high expenses, and unexpected events such as a pandemic or natural disaster.

2. What are the factors affecting working capital management?

The factors affecting working capital management include the nature of the business, the business cycle, the company’s financial policies, the availability of credit, inventory management, accounts receivable and payable management, and the overall economic environment.

3. How do you increase working capital balance?

There are several ways to increase working capital balance, including improving inventory management, negotiating better payment terms with suppliers, accelerating accounts receivable collections, increasing sales, reducing expenses, and obtaining additional financing