Working capital management for small business

Many small businesses struggle with managing their working capital. Working capital refers to the amount of net short term assets available to finance the day to day operations of a business. Typically the net short term assets will include receivables plus inventory plus cash less any short term payables and credit facilities. 

Receivables are amounts owing from customers from past sales. A high receivables balance will indicate a generous credit policy. The problem with too much credit to customers is that it ties down cash which should be available for financing the business. Credit should be limited to specific customers who have demonstrated that they can repay within agreed terms. Ideally you want to have a written credit policy as a business which spells out the conditions for giving out credit and the maximum exposure you’re willing to accommodate.

Inventory is raw materials, work in progress or finished product not yet shipped to the customer. Too much stock will reduce available cash for the business. Inventory should only be stock piled for accepted orders to limit costs. In some businesses stock is the bloodline without which the business will struggle. Most retail outlets, supermarkets, etc. need high levels of stock. An inventory analysis should be regularly performed to determine the nature of stock, it’s value, holding costs, minimum holding quantities and age. Slow moving items should be phased out in preference for faster moving items.

Supplier credit is essential for business survival and should be negotiated at every chance. However if you delay too much or default on payments you lose trust among your suppliers and they will take their business else where.

At some point a small business will need access to flexible credit which they can use to finance operations. Typically you will need some kind of overdraft facility where you pay interest only on over drawn amounts. This should be a last resort after optimizing receivables, inventory and supplier credit.

Cash is the bloodline of the business. The cash available depends on many factors but primarily comes from your sales volume, pricing, credit policy, inventory control, cost control, and financing model you are using. Excess cash can be invested in short term money market accounts. Tight controls should be put in place to limit loss from fraud and mismanagement of cash.

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