As IT leaders of midmarket companies look to expand their roles understanding their organizations, finance is key to their growth and success. The National Center for the Middle Market recently posted a series of articles on working capital, along with a downloadable report, "Working Capital Management." Below is the first blog post (with links to the others), which explains what working capital management is and why it matters.
What could your organization do with an extra million (or more) in cash? You can probably think of a dozen or so answers right off the top of your head. And that’s without taking the time to investigate potential short- or long-term investment opportunities that could open up, if, in fact, you had that extra cash in hand.
Simply put, businesses with more cash are more agile and more competitive when it comes to taking advantage of growth opportunities. They are in a better position to invest in R&D, infrastructure, or even acquire another company. They can meet their expenses and pay down any debt. And they’re more attractive to potential investors. Overall, businesses with plenty of cash are more stable and better positioned to weather volatile economic conditions without having to resort to expensive short-term financing.
If only you had that extra cash . . . The good news is, you probably do. It just may be tied up at the moment in less-than-optimal working capital management practices.
What Exactly Is Working Capital?
Working capital is essentially the difference between a firm’s current assets and current liabilities. It is primarily made up of these three elements:
- Receivables: Money due to a company from its customers for goods and services that have been sold
- Inventory: Money spent for raw materials, components, work in progress, or for finished goods that have not yet sold
- Payables: Money owed for goods or services received
The latest research from the National Center for the Middle Market shows that companies manage working capital far less effectively than they could, and that they can liberate significant amounts of cash in their business — or money that doesn’t require making more sales or imposing cost cuts.
Just how much cash? That, of course, depends on the size of your operation. But our analysis of a hypothetical $100-million-in-revenue materials company puts the figure into the tens (or even hundreds) of millions of dollars annually.
Managing Working Capital
Here are some high-level keys to managing your working capital elements to free up more cash:
- Collect faster. The sooner you can collect your receivables from your customers, the sooner it becomes cash in hand, versus money owed to you. The Center’s research suggests that speeding collections by just a couple of days can have a major impact on the balance sheet.
- Reduce your inventory. If your business can get by with less on its shelves, then the cash that’s currently invested in materials and components can become cash that is back in your coffers. Because of the significant influence of inventory on all other aspects of a business, and because your company has complete control over this aspect of working capital (as it’s not influenced by customer terms), this area may offer the greatest opportunity for middle market firms to free up more cash in their businesses.
- Pay later. While it’s not advisable to be late on your bills, if you can take a few more days to pay, it can have a significant impact on the amount of available cash your business has. At the very least, you should be taking full advantage of the terms your vendors offer. Paying early puts more cash in their pockets, not yours.
There are a lot of variables in play with each of these elements. And your working capital management strategy must take into account the whole range of relationships with your vendors and customers, as well as the capabilities and efficiency of your finance and operations functions. But given the amount of cash at stake, it’s worth a closer look.
To learn more about working capital and management practices that can make a major impact on the bottom line for your business, see the Center’s full research report, "Working Capital Management: How Much Cash Is Your Business Tying Up?"
The NCMM is organized and run by The Ohio State University Fisher College of Business, with financial backing from Cisco, SunTrust and GrantThornton. GE helped the university launch the center several years ago.
Another valuable article in the series, about your approach to working capital, can be found here.