How to make working capital a source of growth capital
A growing business traditionally requires more capital, not necessarily to support operating expenses, but to finance tied-up capital associated with growing sales. Usually, profit created cannot alone support growth and business owners are necessitated to either raise capital, take up loans or simply hold back the growth until the company can finance it on its own.
This article sets out to discuss how hands on working capital management can become a source of growth capital as an alternative to raising external capital.
The formula for calculating working capital is thus:
Mathematically we derive that reducing working capital can be done either by reducing inventory or receivable or increasing payables – or a combination thereof. Let’s discuss these three in individually.
Factors driving inventory include number of items in inventory, distance to and flexibility of suppliers, throughput time in production, etc. Workstreams that can be created addressing a reduction inventory include for instance:
- Investigate if your supplier(s) can hold a consignment stock in your warehouse, the items only become yours when you call on the inventory. This can be possible with longstanding suppliers and/or cash rich suppliers
- Reduce complexity in your inventory – attempt to carry fewer versions. It is usually the case that 80% of sales is derived from articles constituting 20% of inventory. One can decide to increase the availability of high sales items and make some less sold items less available. This strategy can also be facilitated by increasing the prices of less common items thereby driving the volume to the higher volume goods. It is traditionally the case that the low volume items carry a proportionally higher cost which is rarely taken into consideration in pricing.
Accounts receivables constitutes invoices sent but not yet paid. Receivables is the function of payment terms agreed in negotiation or simply written on invoices sent out. Examples of initiatives to reduce accounts receivables include:
- Reducing days payment outstanding (DPOs) on invoices sent to your customers. A common number of payment days is 30 – but more and more companies reduce this to 15. For some customers this can be easily achieved whereas others will want something for it – most commonly reduced prices
- Introduce cash-on- delivery discounts (COD). Many customers are happy to pay almost instantly if they are able to get a couple of percent discount on the invoice amount
- The selling of invoices to credit institutions is called factoring. Depending on your credit history and the nature of the invoices the haircut on the invoice amount varies. The downside of factoring is that buyers of invoices would like a long term relationship (no one off business) and the credit institution will take over the customer relationship on the payments front which might damage future sales.
Accounts payables is the sum of all outstanding supplier payments. They are a function of the payment terms laid out on incoming invoices. Much can be done on the payments side, including for example:
- Dragging out DPOs – if a company has on average 30 days payment terms, it is more or less accepted to pay within 33-36 days representing an increase in payables of 10-20%.
On maturity, pay your invoices with a credit card. The most common number of payment days on a credit card is over 30 days thereby doubling your accounts payables. Many suppliers however do not accept credit card payments, this is where Billhop will be able to help you.
To read more, please visit our start page at Billhop.com/ie.
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