Financing your company’s growth in an uncertain economic climate can be risky. While the cost of borrowing may be historically low at the moment, it is not always easy for private companies to access that capital. In addition, concerns about rising interest rates and global economic uncertainty make most business owners think twice about taking on additional debt. However, one possible way to finance growth in this environment is through your working capital, which is generally your company’s current assets, less any liabilities.
Improving your working capital can free up cash to reinvest in your business without taking on extra debt. These reductions do not need to come at the expense of customer service or top-line growth. In fact, managing your working capital properly can actually improve relationships with your suppliers and customers and increase margins.
The key to improving your working capital is to take a systematic and sustainable approach. Extending credit terms with vendors or instituting more aggressive collection practices with customers may drive short-term improvements, but the long-term effects could be devastating. Instead, your entire organization needs to commit to improvements by following three simple steps: Analyze, Diagnose and Implement.
In the Analyze phase, review your historical working capital trends. Are there peaks and valleys? What drives those fluctuations? Based on this information, begin projecting your cash flow requirements for the upcoming three months. How accurate are your forecasts? What causes the variances? This should point you towards areas for improvement. Good decisions are driven by accurate and reliable information. Many private companies will benefit by increasing their focus in this area.
In the Diagnose phase, identify the root cause of your working capital issues. For example, if you have accounts receivable issues, the solution may lie with the sales staff. Perhaps they are being compensated based on revenue, without any consideration towards cash collection. This can drive the sales team to accept customers with weak credit, or negotiate unfavourable credit terms in return for closing a deal. These types of behaviours can be eliminated through changes to your employee compensation and incentive plans.
The Implement phase is where the rubber hits the road. Once the root causes have been identified, your organization needs to work together to make the necessary improvements. For example, a manufacturing company that is experiencing rapid growth may be tempted to build in “safety stock” into the inventory to ensure that orders can be delivered to customers on time. It can be easy for this excess inventory to grow out of control — your buyers purchase extra raw materials, your production staff build to stock, and your sales staff overestimate demand. All of a sudden, inventory may have grown by 50 per cent to support your projected sales growth of 15 per cent. Eliminating this extra inventory requires constant communication and co-ordination between purchasing, production and sales, but the payoff can be valuable.
This cycle of working capital improvement is not a one-time project, it’s a continuing process. Ongoing analysis leads to the diagnoses of new issues and the implementation of new solutions. Each time the company goes through the cycle, more cash can be freed up. Before you know it, there are funds available to pay down debt, buy new equipment, or invest in other parts of the business. This may ultimately lead to sustainable — and profitable — growth.