Debt-Free Ways to Optimize Working Capital
October 25, 2022 |
The C2FO Team
Your business needs working capital to survive, but do you know how to find it when you need it? Loans aren’t the only solution. Use these debt-free ways to improve cash flow and increase your working capital.
Having sufficient working capital is vital. It impacts every aspect of your business, from keeping the lights on to paying employees, vendors and rent, to your ability to invest in long-term growth. To remain resilient in a difficult economy and keep growing, you need the working capital to fund operations and reinvest into your business. However, you might be unsure how you can obtain capital when you need it most.
Affordable working capital financing can be hard to come by and harder to get approved. For this reason, many companies incur unnecessary debt to meet their needs, when in fact there are many other steps they could take to improve business processes and increase their working capital without taking on new debt. Here are some highly effective and debt-free ways to optimize your working capital:
Leverage dynamic discounting
A great way to optimize working capital is to use innovative solutions that are designed to help you streamline and automate existing processes. For example, you could leverage an early payment platform with dynamic discounting. When your cash is tied up in accounts receivable due to extended terms on customer invoices, it can have a significant impact on your working capital. Using a dynamic discounting early payment solution can help your business get paid faster for your outstanding receivables in exchange for a flexible discount.
Unlike static discounting, dynamic discounting enables your customer to pay at any time and get a discount that adjusts automatically based on the payment date. These programs generally allow you to choose the level of discount you offer customers as an incentive for early payment. This way, you exercise more control over when your business is paid and optimize cash flow. Furthermore, early payment programs generally offer lower-cost access to capital and make capital easier to obtain than traditional funding sources.
Shorten your operating cycle
One of the most effective ways to increase cash flow and, in turn, optimize working capital is to shorten your operating cycle. The working capital cycle, also known as the cash conversion cycle, refers to the length of time it takes to convert your net working capital or money tied up in production and sales into cash. Businesses typically try to manage this cycle by selling inventory quickly, collecting revenue from customers promptly and paying bills slowly.
The longer the operating cycle, the greater the impact it has on your working capital. To shorten your operating cycle, you need to improve one or more of its three components: inventory, accounts receivable or accounts payable. For example, you might decide to increase the efficiency of your accounts receivable processes to speed up payments. Having less cash tied up in receivables, payables and inventory leads to more working capital.
One place you might not think to look if you want to improve working capital is in your expenses. Are there any business expenses that are no longer essential for your operations? Perhaps there are tools or services you no longer use or can downgrade. Carefully evaluating your business expenses can often uncover opportunities to reduce or cut unnecessary costs. This can help you to improve your overall liquidity and optimize your working capital.
You may be able to find ways to save capital by sourcing vendors or raw material providers more strategically. Also, depending on your business classification, industry and vendor terms, you could potentially negotiate discounts or other incentives to save money.
Review profit margins
Low profit margins are an often overlooked cause for cash flow challenges that can ultimately affect your working capital. Inflation, increasing interest rates, higher wages and rising costs can quickly add up and cut into your margins. If you’re at the point where you’re feeling the pressure of high costs, it may be time to consider increasing your prices to protect your margins.
While you may be hesitant to raise your prices, most customers understand that you need to adjust rates occasionally to protect your margins and continue operating. It’s possible to increase prices without losing business; you just need to ensure you use fair judgment and are transparent with your customers.
Liquidate unused inventory
Inventory management plays an important role in your net working capital. Inadequate levels of stock aren’t good for the performance of your business. However, excess inventory can become a major setback if it lengthens your inventory turnover ratio, which is the rate at which you convert your inventory to cash.
Stock that sits on the shelves for too long can tie up cash that could be used for other purposes. Inventory sold will always provide more cash, so look for opportunities to quickly convert inventory to cash. If you want to accelerate your inventory turnover, you might consider getting rid of stale stock by holding a sale or selling it to a liquidation company.
Avoid using working capital to finance fixed assets
Using your working capital to finance fixed assets such as equipment, buildings, vehicles or land is never a wise idea. These are typically expensive assets that are used to generate long-term growth. Using working capital to pay for them not only depletes your reserve but also can increase your business’s risk profile, which financial institutions use to determine creditworthiness. Instead, you can preserve your funds and avoid obstacles to accessing working capital financing by opting to lease fixed assets or use a long-term loan to fund them.
Collect bad debts
To optimize working capital, you should work toward tightening your collection and accounts receivable processes. Bad debts, or uncollectible receivables, can have a significant impact on your working capital. Therefore, you should review your invoicing, collection and credit management processes to eliminate inefficiencies that may be causing bad debts. Consider solutions that can help to ensure a prompt and timely collection of your invoices, such as implementing an early payment program or automating payment processing.
Whether you need to access more working capital to carry you through a slow season or capitalize on a growth opportunity, there are many debt-free approaches you can take to boost your reserve. In fact, it’s in your best interest to employ these working capital optimization tactics year-round, rather than wait until you’re in a pinch.