Ask FundThrough

Working Capital

How to Improve Working Capital and Liquidity

how to improve working capital

Business financing is not the only way how to improve your working capital. Let’s discuss 12 smart, yet simple tricks to help bolster your business’ cash flow.

What Is Working Capital?

Working capital is the amount by which your current assets exceed your current liabilities. In layman’s terms, this is your cash on hand. It’s the money you have available at the drop of a hat for whatever need may arise, whether it’s filling in a new order or paying your employees.

How Much Working Capital Do I Need?

How much working capital your business needs will depend on a few things including type of business, operating cycle, and management goals. While a large business might be able to get away with negative working capital because they can often raise funds quickly, small and medium-sized businesses don’t have that luxury and must work on how to improve working capital.

Having positive working capital – where a business’ current assets exceed its current liabilities – is important for businesses in order to maintain their day-to-day health, future growth, and long-term success.

Understanding Your Working Capital

Too often, businesses approach financing and cash flow management with a closed mind. They need to know one thing right away: Business financing is not the only way how to improve working capital.

Don’t fall into the mindset that long-term loans and selling equity are the only ways to get the money you need. A few simple changes to cash management can quickly free up needed cash.

If you run a business, you know that sustaining self-financing for a prolonged period is incredibly difficult. Working capital financing is necessary to bolster cash flow.

By improving the way you manage your working capital, you can minimize the number of external investments and loans you accumulate during a fiscal year. Then, you can squeeze extra funds from your firm by maximizing your key drivers of healthy cash flow. 

Here is how to start that process.

12 Smart Ways How to Improve Working Capital

The first place to start when looking at how to improve your business’ working capital is to thoroughly examine your current financial situation. 

If you ask the right questions, you can likely uncover multiple ways to improve your working capital management:

  • Can you improve your business model to minimize or avoid unnecessary expenses and delays in payments? (Perhaps by changing contract terms with buyers?)
  • Is there an alternative approach that requires less working capital, without hurting your sales revenue?
  • Is there a way you can further leverage your assets to generate additional funds?

 

If you answered “yes” to any of these questions, there’s room for improvement in your cash flow management process. But where do you go from here once you have this knowledge?

When you understand all the different ways in which you can increase working capital for your company, you’re setting your business up for success both now and into the future. These are a few of the most common working capital improvement techniques that could give your business a nice cash boost, or at the very least, help to reduce cash waste.

1. Shorten Operating Cycles: File Your Invoices on Time

Your operating cycle starts when you begin spending money to work on a project. The capital cycle ends the moment you receive payment for the work. Limiting the time between these points is essential. If you wait weeks to send your invoices, it will stagger your profits and ultimately hurt your cash flow.

Depending on your industry, you may request payments within 15 or up to 60 days. Consider what is the norm for your industry and try to minimize the time between project completion and sending out an invoice. Longer operating cycles, due to delayed invoicing, could very well translate into lost income and poor liquidity.

2. Perform Thorough Credit Checks on New Customers

A customer’s bad credit score could have a direct impact on your accounts receivable. You want to make sure your customers can afford to pay their bills.

Depending on the scope of the order, you may want to run a credit check on a client before signing a deal with them. You should also consider lower credit limits for new customers, until they’ve proven themselves a reliable payor.

3. Collect Outstanding Invoices on Time

Your accounting department needs to closely monitor all past due accounts to maintain cash inflow. Send out inquiries if payments are delayed beyond the accepted time frame. It is crucial to uncover any issues that may be preventing your client from completing their payment.

Reminders also help speed up the collection process. You don’t have to wait until the last day to collect your accounts payable or send a reminder. If at all possible, try to automate this process so that you aren’t wasting valuable time chasing down payments. 

You might also consider incentivizing receivables, so that your customers pay on time or ahead of schedule. Late-paying customers can cause a cash flow crunch, but a small payment discount can go a long way in getting the payments to come in ahead of net terms. Additionally, a late fee penalty is also effective at incentivizing clients to avoid late payments, ultimately improving your cash flow and access to working capital. 

4. Limit Unnecessary Operational Expenses

Apply transparency and clarity when it comes to how much you spend. This begins with examining your budget and breaking it down to its components. Make sure you’re not overspending in any area of your business finances. Set rules to restrict any unnecessary spending.

You may also want to examine your office and business trip expenses if you’re looking for ways how to improve working capital. Focus on the bills that maintain your functionality as a company. Small amounts of non-essential cash spending could instead be used to further fuel your working capital and growth.

5. Increase Sales Revenue

This way to improve your working capital may seem obvious, but more and bigger sales equals increased revenue. Focus on expanding your sales force and exploring new marketing channels.

Base your pricing on profit margins and sales to ensure your rates are reasonable and workable.

Keep in mind that, depending on your business cycle, profits from revenues may not come in time to keep up with the bills. If this is the case for you, don’t forget to also work on areas of cost reduction.

6. Improve Inventory Management & Avoid Stockpiling

Imagine your inventory as stacks of dollar bills. Every unsold item in your warehouse is essentially a pile of money sitting on the shelf, not being put to use. This decreased liquidity makes your business less agile and less competitive.

To ensure maximum cash flow, you have to time your supplies and products to arrive exactly when you need them in order to avoid having excess inventory. Inventory management software is an excellent tool for staying on top of this aspect of your business.

By quickly converting inventory into cash, you’ll have less capital tied up. Another benefit is that you’ll need less storage space, which will also cut some additional costs.

7. Lease Your Equipment

Technology evolves every day. Sometimes it can be financially unwise to keep investing in new equipment. Leasing is one way to avoid making large, repeated investments to stay on top of technological innovations.

It’s also one of the best cash flow management practices out there. 

Apart from leasing equipment from other companies, you can make use of your own assets as a way how to improve working capital for your business. One way is lending your existing equipment when you’re not using it. You can also sell it to a leasing company to get a one-time cash boost. Later, you can lease it back from them only when you need it.

Another piece of equipment that business owners often overlook as a source of revenue is unused office space. Just as one might lease unused equipment, Fundera suggests selling or renting out extra offices as another way to liquidate long-term assets.

8. Leverage Your Accounts Payable

Maintaining good relationships with your creditors is often overlooked as a way how to improve working capital. A key part of this is maintaining a good credit score. If you’re experiencing cash flow problems, good credit and positive relationships will help you negotiate extended payment terms. This, however, is not a permanent solution to any ongoing financial issues.

While you may want to collect your accounts receivable as quickly as you can, you should delay your accounts payable as much as possible. You can use wire transfers to complete your payments on the very last day they are due. You can also consider practices like invoice financing to ensure that you get the cash you need on your terms. 

Also, when you work with vendors, be sure to ask about any deals or discounts available for new customers. And don’t be afraid to renegotiate payment terms once you become a loyal customer.

9. Transparency in the Invoice and Reporting Process

Reporting is a major part of the accounts receivables process, so being transparent with invoices and reporting will help you maintain a clear and accurate understanding of where your business is financially at any given time. 

When invoices are no longer lost in the shuffle, you can look at your books to easily determine how long it takes to process an invoice, or where an invoice is within the payment queue. This way, if you notice any cash flow gaps or have an unexpected expense pop up, you can tackle it proactively. 

You may also identify bottlenecks that can be easily tended to and resolved, further increasing your access to working capital and strengthening your company’s cash position, resulting in a more favorable balance sheet. 

10. Collaboration Is Key to Success

Don’t be afraid not to go it alone – no person is an island, and the same can be said for businesses. Many hands make light work of ensuring your business has access to the cash flow it can count on. 

For example, at FundThrough we’ve partnered with QuickBooksEnverus, and other accounting software to make it easy to get a cash flow boost based on your outstanding invoices. Once your accounts are linked, you can simply select an invoice you’d like to fund right from within your accounting software. Our AI-powered system works its magic, and funds are deposited directly to your business account – often in just a matter of days!

11. Take Advantage of Any Tax Incentives

Another smart way to increase your working capital is to take advantage of any tax incentives your business is eligible for. Many provinces and states offer incentives to businesses and their investors, if they invest in businesses within those regions. Tax incentives are offered for various reasons, as they help businesses remain competitive.

Common tax incentives include: 

  • If you’re a new business, you may qualify for a “tax holiday” which can help reduce your tax obligations. 
  • There are also tax incentives for special zones within a country. 
  • Reduced tax rates. 
  • Exemptions from various taxes, especially those collected at the border.
  • Investment allowance lets you deduct a certain fraction of an investment from taxable profits (in addition to depreciation).
  • Accelerated depreciation lets you claim depreciation at a faster schedule than available for the rest of the economy.
  • Financing incentives that reduce tax rates applying to providers of funds, (e.g., reduced withholding taxes on dividends).

12. Manage Debts Smartly

Another way how to improve working capital is to carefully manage your debts. The first aspect of this strategy involves ensuring you meet your debt obligations on time in order to avoid any penalties or additional costs. You can do so by setting up automatic electronic payments.

The other aspect of smart debt management involves reviewing the interest on any business loans or other forms of fixed debt your business might have, and checking to see if you qualify for a more favorable interest rate. This can help reduce your monthly debt payments, freeing up more working capital to reinvest in your business. Alternatively, you may choose to use any saving to help clear outstanding debts faster and thus reducing the overall cost of borrowing. 

Improve Working Capital to Keep Your Business Running Smoothly

By following these helpful tips, you should have a better understanding of how well-managed working capital is beneficial to your business, and how yours can be improved. 

Through responsible spending, mindful collection, and making the most of your available assets, your company will have the capital it needs to succeed.

If you’d like to find out more about capital financing, check our article, What is Working Capital and How Does it Affect Business Cycles?

Put FundThrough to Work for Your Business

We help small business owners navigate cash flow hurdles every day. Sign up in just minutes and get access to customized funding solutions based on the size of your invoices and your customers.

Suggested Readings

Everything you need to build the business of your dreams — delivered straight to your inbox

Explore fast payments with an experienced fintech

Interested in possibly embedding FundThrough in your platform? Let’s connect!