Proactive working capital management is essential to successful business operations. However, on average, businesses aren’t managing their working capital as efficiently as they have in the past, according to The Hackett Group, a digital transformation and AI strategy consulting firm. The study found all elements of the cash conversion cycle (CCC) deteriorated by an average of 1.3 days (or 4%) from 2022 to 2023. The sectors reporting the biggest CCC deterioration include marine shipping, biotechnology, oil and gas, and food and staples retail. Here’s why working capital management is so important and how your business can avoid the trend revealed in the study.
Why working capital matters
Working capital equals the difference between current assets and current liabilities. Organizations need a certain amount of working capital to run their operations smoothly. However, excessive amounts can hinder growth and performance. The optimal amount of working capital depends on the nature of your company’s operations and its industry. Working capital management is often evaluated by measuring the CCC, which is a function of three turnover ratios:- Days in accounts receivable outstanding,
- Days in inventory outstanding, and
- Days in accounts payable outstanding.
Ways to shorten your CCC
Here are three ways to reduce the amount your business has tied up in working capital:- Collect receivables faster. Possible solutions for converting accounts receivable into cash faster include: tightening credit policies, offering early bird discounts, issuing collection-based sales compensation and using in-house collection personnel. Companies can also evaluate administrative processes — including invoice preparation, dispute resolution and deposits — to eliminate inefficiencies in the collection cycle.
- Reduce inventory levels. The inventory account carries many hidden costs, including storage, obsolescence, insurance and security. Consider using computerized inventory systems to help predict demand, enable data sharing up and down the supply chain, and more quickly reveal variability from theft.
It’s important to note that, in an inflationary economy, rising product and raw material prices may bloat inventory balances. Plus, higher labor and energy costs can affect the value of work-in-progress and finished goods inventories for companies that build or manufacture goods for sale. So, rising inventory might not necessarily equate to having more units on hand.
- Postpone payables. Your company can increase cash on hand by deferring vendor payments when possible. But be careful: Delaying payments for too long can compromise a company’s credit standing or result in forgone early bird discounts. Many organizations have already pushed their suppliers to extend their payment terms, so there may be limits on using this strategy further.
