Managing working capital: tips and techniques for CFOs

Effective working capital management is crucial for maintaining a company’s financial health and operational efficiency. Here are some tips and techniques for CFOs to manage working capital effectively.

Understand working capital components

Working capital is the difference between current assets and current liabilities. It includes components such as cash, accounts receivable, inventory, and accounts payable. Understanding these components and their impact on liquidity and operations is essential for effective management. CFOs should regularly review the balance sheet to monitor working capital levels and identify areas for improvement.

Optimise cash management

Effective cash management is at the core of working capital management. CFOs should implement practices to optimise cash flow, such as:

Cash flow forecasting: Develop accurate cash flow forecasts to anticipate cash needs and surpluses. Regularly update these forecasts to reflect changes in business conditions.

Centralised cash management: Use centralised cash management systems to consolidate cash balances and improve visibility. This enables better decision-making and more efficient use of cash resources.

Cash reserves: Maintain adequate cash reserves to cover unexpected expenses and short-term obligations. The appropriate level of reserves will depend on the company’s risk tolerance and cash flow volatility.

Improve accounts receivable management

Managing accounts receivable effectively ensures timely collection of payments and reduces the risk of bad debts. Techniques for improving accounts receivable management include:

Credit policies: Establish clear credit policies and conduct thorough credit checks on new customers. Set credit limits and payment terms that balance sales growth with risk management.

Invoicing practices: Implement prompt and accurate invoicing practices. Ensure that invoices are sent out immediately after goods or services are delivered.

Collections process: Develop a structured collections process, including regular follow-ups and reminders for overdue accounts. Consider offering early payment discounts to incentivize prompt payments.

Accounts receivable ageing: Monitor the accounts receivable ageing report to identify overdue accounts and take corrective actions. This report categorises receivables based on how long they have been outstanding, helping to prioritise collection efforts.

Streamline inventory management

Efficient inventory management helps reduce holding costs and minimise the risk of obsolescence. CFOs can optimise inventory levels by:

Demand forecasting: Use demand forecasting techniques to predict future sales and adjust inventory levels accordingly. Accurate forecasts help avoid overstocking and stockouts.

Just-in-Time (JIT): Implement JIT inventory systems to align inventory purchases with production schedules. This minimises inventory holding costs and reduces waste.

Inventory turnover: Monitor inventory turnover ratios to assess how quickly inventory is being sold and replaced. A higher turnover ratio indicates efficient inventory management.

Safety stock: Maintain an appropriate level of safety stock to buffer against demand fluctuations and supply chain disruptions.

Manage accounts payable efficiently

Managing accounts payable effectively involves balancing the need to maintain good supplier relationships with optimising cash flow. CFOs can achieve this by:

Payment terms: Negotiate favourable payment terms with suppliers. Longer payment terms improve cash flow, but ensure they do not damage supplier relationships.

Early payment discounts: Take advantage of early payment discounts offered by suppliers, but only if it makes financial sense. Compare the discount rate to the cost of alternative financing options.

Accounts payable scheduling: Schedule payments to coincide with cash inflows. This helps maintain a positive cash flow position and ensures that obligations are met on time.

Vendor management: Maintain strong relationships with key suppliers to negotiate better terms and ensure reliability.

Leverage technology

Technology plays a critical role in enhancing working capital management. CFOs should leverage advanced tools and systems, such as:

Enterprise Resource Planning (ERP): Implement ERP systems to integrate and streamline financial processes, improving data accuracy and visibility.

Automated payment systems: Use automated payment systems to manage accounts payable and receivable efficiently. Automation reduces errors and accelerates processing times.

Analytics and reporting: Utilise analytics tools to gain insights into working capital trends and performance. Dashboards and real-time reporting provide a clear view of cash flow and liquidity.

Monitor Key Performance Indicators (KPIs)

Tracking relevant KPIs helps CFOs assess the effectiveness of working capital management strategies. Important KPIs include:

Current ratio: Measures the company’s ability to cover short-term liabilities with short-term assets. A higher ratio indicates better liquidity.

Quick ratio: Similar to the current ratio but excludes inventory, providing a more stringent measure of liquidity.

Days Sales Outstanding (DSO): Measures the average number of days it takes to collect payment after a sale. Lower DSO indicates faster collection.

Days Inventory Outstanding (DIO): Measures the average number of days inventory is held before it is sold. Lower DIO indicates efficient inventory management.

Days Payable Outstanding (DPO): Measures the average number of days the company takes to pay its suppliers. Higher DPO indicates longer payment terms.

Implement continuous improvement

Working capital management is an ongoing process that requires continuous improvement. CFOs should regularly review processes, identify areas for improvement, and implement best practices. Encourage a culture of continuous improvement within the finance team and across the organisation.