To determine financial health of any business, a review of how they produce cash flow provides the knowledge about the business staying power. An important indicator of financial health is the accessibility of cash. The first item any bank will examine on a balance sheet is cash on hand. Although “working capital” has a range of meanings, this article will define it as the net liquid assets available to an organization to meet needs of day-to-day operations. Working capital management, cash forecasting, and cash management are three key to the success of an enterprise. When a business’s cash is limited, the staff focuses on creating liquidity for the variety of different sources within the business. For this discussion, working capital is controlled by the management of the three main areas: account receivables, payables and inventory. These three areas represent the items a business can manipulate to influence cash or working capital.
Working capital is important to business type but most important to small public companies. Interestingly, small private and large public companies were less likely to rate working capital as being high or very high in importance, potentially emphasizing how other competing priorities may take precedence. CTP Solutions observed that although working capital management may be identified as a priority, its importance is often not fully understood across the enterprise organization and that management have a continuous challenge to motivate and educate their organizations on the importance of cash flow alongside other priorities. It is important that both staff of finance-related departments and other departments be educated on the connection between a company’s liquidity and free cash flow, and how capital investments, acquisitions, research and development and internal initiatives are funded.
All businesses must apply a high priority to their management of working capital because of the rewards it provides and to avoid problems caused by the lack of cash. Working capital improvement begins with the billing procedure. If the billing procedure is slow, than cash flow will be delayed. Many businesses have turned to electronic billing and attempt to deliver invoices as produced and not at the end of month. Other businesses invoice monthly and rely on email delivery to improve cash flow. Still other businesses must attach proof of delivery and other billing documents and electronic collection and handling improves the ability to quickly transmit billing.
A continuous improvement in cash flow begins with billing but the enterprise mindset is needed to either retain or improve performance. Large events such as acquisitions or mergers often drive the need to look at working capital. Cash flow released from working capital can help to accelerate the payback and synergies of these transactions. There are many elements of working capital management that companies must take into account, but certainly electronic billing is the starting point and if this is handled properly, the other areas will follow.
The individual nature of each business requires a unique approach, and companies must consider all options in order to determine the best methodology to subscribe. There is no “one size fits all” solution, but cash released from working capital is the cheapest source of incremental cash and good cash flow begins with billing timely, accurately and electronically.
Although this report is aimed primarily at financial executives, it is important to note that working capital management is not just a finance concept. Working capital is influenced by nearly all functional areas across a business: operations, sales, finance, procurement, IT and management. Therefore, when an organization decides to implement a working capital improvement program, it means the whole organization should be pulling in the same direction with strong internal leadership.