Working Capital Management

Working Capital Management

Cash is the lifeline of your company. If this lifeline deteriorates, so does your company’s ability to fund ongoing operations, reinvest and meet capital requirements and payments. Understanding your company’s cash flow health is essential to making ongoing as well as critical business decisions. A good way to judge your company’s cash flow prospects is to understand your working capital management (WCM).

What Is Working Capital?
Working capital refers to the cash your business requires for day-to-day operations, or, more specifically, for financing the conversion of a service company’s direct costs into billable services, or inventory into finished goods, which the company sells for payment. Among the most important items of working capital are levels of inventory, accounts receivable and accounts payable.

The better your company manages its working capital, the less your company needs to borrow. Even companies with cash surpluses need to manage working capital to ensure that those surpluses are invested in ways that will generate suitable financial returns for owners and investors.

Timing and lumpiness of payments can pose serious troubles. Manufacturing companies, for example, incur substantial upfront costs for materials and labor before receiving payment. Service companies can receive substantial progress payments which need to fund contract performance. Failure to understand and manage working capital can result in cash shortages and reduced profitability.

Evaluating Companies
Harvest CFO Consulting guides business leaders to place emphasis on supply-chain management to ensure that trade terms are optimized. Days-sales outstanding, or DSO for short, is a good indication of working capital management practices. DSO provides a rough guide to the number of days that a company takes to collect payment after making a sale. Here is the simple formula:

                   Receivables/ Annual Sales/365 Days


Rising DSO is a sign of trouble because it shows that a company is taking longer to collect its payments. It suggests that the company may have cash shortfalls to fund operations and short-term obligations because the cash cycle is lengthening. A spike in DSO is even more worrisome, especially for companies that are already low on cash.

The inventory turnover ratio offers another good instrument for assessing the effectiveness of WCM. The inventory ratio shows how fast/often companies are able to get their goods completely off the shelves. The inventory ratio looks like this:

                    Cost of Goods Sold (COGS)/Inventory


Broadly speaking, a high inventory turnover ratio is good for business. Products that sit on the shelf are not making money. Granted, an increase in the ratio can be a positive sign, indicating that management, expecting sales to increase, is building up inventory ahead of time.

For business leaders and investors, a company’s inventory turnover ratio is best seen in light of its competitors. In a given sector where, for instance, it is normal for a company to completely sell out and restock six times a year, a company that achieves a turnover ratio of four is an underperformer.

Cash is king – especially at a time when financing options are harder than ever. Analyzing your company’s working capital is a key financial management best practice and can provide excellent insight into how well your company handles its cash, and whether it is likely to be able to fund growth and achieve its goals.

Harvest CFO Consulting works with business leaders to help them to understand their working capital position and assists in establishing benchmark targets as to working capital and implement best practices and strategies to meet this target.

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