A Guide To Managing Your Working Capital

More motivating business advice from the Numbers Coach.

In my last article we explained what Working Capital is: essentially it’s the money tied up with your customers (debtors) who haven’t paid yet plus the money tied up in stock on the shelves of your business, and then you take off what you owe your suppliers (creditors).   

So at its simplest, managing working capital is about three things:

1. Getting your customers to pay quickly
2. Ordering sensible amounts of stock
3. Negotiating favourable payment terms with suppliers…. Although that’s easier said than done when you are a new business.

Let’s look a little closer at how you should manage these three factors:

Getting your customers to pay quickly

• Link price negotiations with payment terms, such as: “I will accept your proposal if you pay within X days or pay a deposit”.
• Get deposits on order – it is not unusual in creative businesses to get 50% on order to cover materials.
• If you are doing a big contract, break it down into stages which trigger payment milestones.
• If you are working for a big company make sure you get a Purchase Order number.  This confirms the work is authorized.
• With a new customer you are offering credit terms to, as well as running  background checks (www.duedil.com is a useful site for this) make sure you follow their invoicing procedures to the letter.  Also, ring up and check they have received the invoice and are happy with it.
• Use accounting software so you can easily produce an aged debtors list – this report shows customer name and what is owed by age of invoice, i.e. 30, 60 or 90+ days.
• Are you able to include a subscription element to your business model? An example of this would be customers paying monthly for a regular delivery or service.

Ordering sensible quantities of stock

• This is not immediately obvious and a bit counter-intuitive because by ordering more you can get a better price…  However, in the early days my advice would be to manage for cash rather than profitability by ordering in smaller quantities.  Yes you end up paying more per item, but you reduce the amount of cash tied up.  Plus you may well find you need to adapt your order, which will be harder if you have already bought large volumes of the wrong items.

Negotiating favourable payment terms with suppliers

• The keyword here is negotiate – just stringing your suppliers along is not sustainable in the longer term.
• Get to know your suppliers so you can understand what is important to them – there may be ways you can help them over and above just buying from them. They may be interested, for example, in a long-term commitment or a regular buying commitment that helps them plan.
• If they are bigger companies, your suppliers may also be a source of finance for you – they may be interested in carrying out what’s called a Corporate Joint Venture.

On a final note, be aware that despite your best working capital management, as your business grows the amount of working capital you will need will grow, and the faster you grow the more working capital you will need.  You may have heard of the expression “overtrading”.  This is where a business takes on too many orders, which despite being profitable, the business just hasn’t got the funds to finance.  Don’t become a victim of your own success – manage and monitor your working capital. I hope you find some of these tips useful.

Johnny Martin FCA is The Numbers Coach – an experienced Finance Director who now passionately explains business numbers and jargon. He is a British Library Business Centre partner where he runs regular workshops and he is a mentor for the School of Communication Arts – the world’s best advertising school. Johnny is also the author of the highly acclaimed book:  ‘Understanding Your Business Finances’   You can follow Johnny on Twitter: @numberscoach!