So this week is about how to improve your working capital. In reality this means one thing – making your cashflow better. Who doesn’t want better cashflow?
If you think about how your cash flows through your business you can imagine the working capital cycle
Buy stock – sell it – pay for it – wait to be paid
The longer this cycle takes, the more cash you’ll need just to stand still.
The good news is there are several ways you can continually work on this to get your cash flowing faster.
Stock
Keep your stock balance as low as possible without affecting customer service. Stock should be turned into sales and therefore cash as quickly as possible. Stock can absorb huge amounts of cash. When you look at your stock imagine all the pound notes sitting on your shelves.
Task someone with managing stock. If it’s not actually anyone’s job you can be sure it won’t get managed:
- You need to see your stock balance every month. If you have raw materials, work in progress and finished goods you’ll need these figures separated out.
- Put your monthly stock balance on a graph – that way you’ll easily spot an upward trend in your stock.
- Make sure people can’t order stock without a signed purchase order and that stock isn’t ordered until it’s really needed – operate to Just-in-Time as far as possible
- Keep an eye on old or slow moving stock, just how much cash is tied up there? This needs to be sold through rather than leaving it on the balance sheet to rot.
Work in progress in a service business
- You have to know weekly / monthly how many hours and how much revenue you’ve got in your work in progress. Anything you haven’t billed for yet is staff labour you’ve paid for. Monitor the value and age of your work in progress constantly, anything you’ve not billed has to be funded by you. Put it on a graph so you can see if it’s building up.
- If you work on long term projects see if you can agree stage payments or invoice monthly for the work you’ve done.
- The older WIP gets, the more likely you’ll have write offs, so you’ll be writing off revenue having paid for the work to be done.
Debtors – customers have to pay you on time
- Check your debtors report every week, ask questions. Old debts can build quickly if you’re not on top of them. If your terms are 30 days, then why do you have debtors in the 60 and 90 day columns? Something isn’t right.
- Invoice when you’ve supplied your goods or services; don’t leave it until month end.
- Really keen credit control is absolutely essential. There are two detailed blogs about this on my website (I can’t give you the links unfortunately as we’re about to move onto our new site)
- Train your customers to pay you on time, I promise it’s possible!
Cash
- Cashflow must be controlled otherwise it takes on a life of its own and you’ll become a slave to it.
- The 13 week rolling cashflow is a must; make sure you see it every week.
- Unless you’re awash with cash, don’t use it to buy assets. Long term assets should be matched with long term finance, you shouldn’t use short term cash to pay for long term assets
Creditors
- Make sure creditors are set up on the right terms on your system
- Make sure you don’t pay early
- See if you can negotiate longer settlement terms – you never know until you ask.
For a £1m turnover business, saving 15 days on debtors will put £49k extra in your bank account. Not too shabby I’d say.
What are the warning signs?
If your cashflow is tight on a regular basis then please don’t just accept that as a way of life. It’s a clear warning sign that something is wrong with your business. It may be a lack of profit or a problem in your working capital, but either way it needs your urgent attention.
If you have trouble paying your VAT, corporation tax or PAYE then you have a big red flag waving. This was never even your money so it’s telling you that you’ve been using HMRC funds to plug a hole in your own finances.
So can you have too much working capital?
On the flip side, too much working capital tied up will slow you down and stop you growing. Be wary of holding too much cash, especially if you should be investing in the business to keep it growing and keep it competitive.
What you should be on the look-out for
Make sure your information includes the age of your debtors and stock. The older debts and stock get, the greater risk you’ll have to write it off, which means taking a hit on profit.
How you can manage it
Remember that what gets measured gets improved. Taking some simple steps to monitor your working capital will inevitably mean your cash will improve.
When you work out how much cash is actually tied up in your business in your stocks and debtors, you can see just how much difference you could make to your cashflow by tightening up.
Funding your working capital
There are a number of ways to finance your working capital; invoice discounting, stock finance, overdraft (less so these days), equity investors. Peer to peer funding is also becoming increasingly popular as banks shy away from working capital funding. And of course don’t forget profits. Retaining profit and cash in your business forms an important part of your working capital. And the more profit you retain, the less you need outside funding.
If you’ve got any form of funding, your bank or investors will be paying close attention to how you manage your cash, which means you need to pay attention as well.