As every business owner knows, it is one thing to show a profit on the books, and another thing to have healthy cash flow. One of the best ways to make this a better year for your business is to focus on improving cash flow, through better management of Working Capital.

Working Capital is a financial measure of liquidity – the ability of a business to meet its payment obligations. It is the excess of current assets over current liabilities. In other words, it is the amount of cash you get your hands on in the relatively near term.

Current assets include cash, accounts receivable, inventory and other assets that are expected to be converted to cash within 12 months. Current liabilities include accounts payable and accrued expenses for salaries, taxes, and interest as well as loan payments and other liabilities due within 12 months.

The GOOD news is that effective management of working capital can strengthen a company by providing funds to support operations and to reduce financing costs and dependence on external sources of financing.

The BAD news is that poor management of working capital can weaken a company by draining cash resources required to meet payment obligations, resulting in the need to rely on costly new debt or even more costly new equity financing.

The following are some of the actions that management should consider taking to improve working capital:
1. Establish firm credit policies and check customer credit references
2. Require advance payments or deposits from customers that have poor credit
3. Encourage credit card payments – but be aware of the credit card fees you will be charged
4. Invoice customers promptly – and follow up on any disputes quickly – to reduce collection time and disputes
5. Contact chronic late-paying customers prior to invoice due date to address potential payment issues
6. Offer customers discounts for early payment
7. Adopt “just in time” inventory procedures for purchasing
8. Reduce inventory levels and monitor closely to minimize excess or slow moving stock
9. Negotiate with suppliers for longer payment terms
10. Minimize your outstanding line-of-credit balance through a “sweep account” at your bank

Of course, all of the above actions must be weighed against potential negative consequences, and must be based on consistent and fair customer and vendor policies.
Next time, we’ll take a look at the best ways to set and measure goals for healthy working capital.

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