One critical purpose of Working Capital Management is to ensure liquidity – remember cash-flow is the oxygen of a business, if cash stops flowing in the business dies. Another aspect of Working Capital Management is that if working capital is optimised it makes the business more profitable.
Sales and getting the cash in
There is an old adage, “a sale is not a sale until the money is in the bank”. So what ensures that you get the money in the bank?
- Take steps to ensure that your customers are credit worthy – but you can’t rely entirely on reports from credit bureaus. Your salespeople can also make assessments of a business by having conversations with clients – this can be done if they receive training in this area and if you deduct any of their customer’s bad debts from their commission. Businesses lose a lot of money by making risky sales to dodgy customers when trying to meet budget. Ask yourself, if you have a bad debt of R10,000 how much in sales would you need to make up for the loss. “Sometimes the hardest decision a manager has to make is to decide which business not to do” – Michael Porter.
- Credit management is not only about chasing up customers for payment. It starts by ensuring you have proof of delivery for goods supplied – or if your business provides services ensuring that the work done is signed off by a duly authorised person. The next step is to make certain that invoicing is done promptly (not accumulated to be done later) and that the invoice is delivered as soon as possible – do not trust ‘snail mail’.
- Another often ignored area is the issuing of credit notes. The customer may have asked for a credit on an invoice and you have agreed to this. The credit note needs to be issued immediately and sent to the customer as quickly as you send invoices. This is because customers will not alter your invoices and process them for payment. They wait until they have the credit note and then process the two simultaneously. I was once doing some consulting work for a company that was experiencing liquidity problems. One of the main reasons I found was that their sales manager, who had to authorise credit notes, would sit on them if he was under budget on sales and wait until the new month before he signed them. This alone caused millions of Rands to be paid late.
- Getting the money in. People oil the wheel that squeaks the loudest. If you are worried that you may lose business because you always demand that your customers pay you on time consider the fact that the customer may be in financial difficulties. If large amounts are involved this could pose a threat to your business. Late payments also reduce your profitability because you then have to finance your accounts receivables (debtors) by borrowing and incurring interest..
An ideal inventory level would be zero. Businesses keep inventory for two reasons. 1. Speculative – they anticipate price increases. 2. Strategic reasons – they don’t have reliable suppliers and feel they have to keep a buffer stock. There may also be the matter of economic order sizes – they import container loads that only get used up over a period of months.
There are costs and risks a associated with holding inventory. These are called ‘holding costs’ – sometimes referred to as ‘hidden costs’ – but they are very real. Some can be quantified and some are risks that have to be considered. Consider the following:
- to rent extra storage space
- additional security costs
- increased insurance premiums
- pay interest on additional money needed to finance increased stock levels
- increased pilferage
- additional handling costs
- additional stores administration
- the goods perish
- the goods become obsolete
- a sharp decline in prices following your having made a purchase
These additional costs could negate the positive effect of the increased margins due to having obtained a lower price for bulk purchases from your suppliers (holding costs are sometimes referred to as ‘carrying costs’). Some of the factors mentioned above are quantifiable costs, and some are risks, such as in the case of the potential for obsolescence.
Many people play a role in inventory management, those preparing sales forecasts, the purchasing staff, and stores managers. You need to keep an eye on all of them. Once when I was working as an accountant at a factory I took a walk to see the store’s manager who was also responsible for making certain purchases from a supplier in Germany. I had difficulty walking through to his office because of newly arrive pallets of chemicals crowding the aisle. I asked about the large size of the shipment and he replied, “There is so much work involved in ordering from Germany that I ordered a year’s supply”. I was speechless.
The management of the above items, accounts receivable and inventory plays a major role in ensuring liquidity.