A business is all about maintaining cordial relations with customers, suppliers, vendors, lenders, and employees. It’s a timely give (payables) and take (receivables). Working capital management is required to ensure this give-and-take happens smoothly. It requires maintaining balance in the inflows and outflows of cash and inventory while providing a more efficient allocation of resources.

The Importance of Managing Working Capital

Working capital is like maintaining a monthly household budget. It has to incorporate inflation, lifestyle changes, life events like a child, any new additional expense, a job loss or a promotion. In business, working capital involves:

  • Debt management: You need sufficient cash to pay your debt obligations promptly.
  • Inventory Management: You need sufficient inventory to meet customer demands while ensuring minimal wastage.
  • Cash management: The time between customer receivables and supplier payables can be tricky. You have to manage the payment cycles and work out a schedule with both parties by offering discounts for early payments or charging interest for delays.
  • Risk management: Working capital management also involves keeping adequate reserves to help the business sustain economic uncertainties, supply chain disruptions, or unforeseen events. 

You don’t want to be in a situation where you realize you only have a week’s cash left. In such a situation, you may not have enough time to negotiate with suppliers or apply for a short-term loan. Hence, working capital management is closely monitored by the CFO. As many small businesses don’t have a CFO, the onus falls on the CEO to keenly monitor the working capital.

6 Occasions Where Small Businesses Should Review Working Capital Strategy

The business operates in a dynamic world. Everything will not remain the same forever. Either the economy will change, your business will grow, or industry trends may change. You must adjust your working capital strategy to such situations instead of continuing to follow the same strategy.

Adjusting To Demand Fluctuations

Most businesses have periods of high demand and low demand. Sometimes, demand is seasonal, such as in the case of the holiday season, back-to-school season, basketball season, winters, and summers. Sometimes, demand is cyclical, as in the case of PCs and mobile phones. And sometimes, it is trend-based, especially in fashion. Being in the business, you must adjust your inventory to the fluctuations of demand. This requires demand forecasting, working out terms with suppliers, or stocking up in advance to ensure your business makes the most of the demand.

Supply Chain Disruption

While demand fluctuates, so does supply. Several events can disrupt supply, like a shortage of raw materials or components, which can increase the cost, your supplier may face business risk, or an accident or natural calamity might damage supplies. It is better to have multiple suppliers and have some buffer stock for emergencies. Depending on how long the shortage lasts, this may require more working capital than a usual day.

The reverse is also possible. There could be excess supply in the market that breaks the price. You see clearance sales, heavy discounts, and freebies to sell inventory in such cases. Such events may reduce profit margins on items sold, but that is offset by savings in storage cost and discounts (if any) for faster payments, thereby reducing working capital needs.

Growth and Expansion of Business

Business expansion and growth need a thorough financial strategy, as you will need additional employees, inventory, and equipment. For instance, opening a new store, launching a new product, accepting a large order, and scaling operations will require more working capital. You may have to adopt an aggressive working capital strategy to execute the growth. It could include lower capital reserve, extending the payment cycle with suppliers, and building new lines of credit at attractive rates.

You could also do the other way round and look at the buffer cash reserve to determine how aggressively to grow.

Changes in Capital Structure and Financing Policies

While debt can provide immediate liquidity, too much debt could increase interest expense. If the company is changing its capital structure or financing policies, such as raising more debt, restructuring debt at a higher interest rate, or increasing dividends paid to equity shareholders, it has to review its working capital requirement. The payment of immediate debt obligations is part of current liabilities and requires more working capital.

Industry Dynamics

Every industry has a different working capital requirement, depending on their supply chain characteristics. While retail businesses have a higher working capital requirement, technology services have a lower requirement. While ensuring an industry-standard working capital, you might have to review your strategy based on industry seasonality and trends that affect demand and supply.  

Macroeconomic Environment

No matter which industry, every business, big and small, is affected by macroeconomic factors like inflation, interest rates, government taxes, recessions and economic downturns. Such events reduce the spending capacity of individuals and businesses and create business uncertainty. At times like these, cash becomes the king and working capital requirements increase. Companies boost their cash reserve and cut costs to keep the business operational.

In any event, the question concerns how much cash reserve a business should keep at a given time while ensuring it does not affect reinvestment opportunities and meets short-term obligations.

Contact Glenn Graydon Wright LLP in Oakville to Help You Plan and Review Your Working Capital Strategy

If your business is undergoing any of the above events, you can consider third-party CFO services to review and adjust your working capital strategy. At Glenn Graydon Wright LLP, our accountants and CFOs can provide accounting and business consulting services. To learn more about how Glenn Graydon Wright LLP can provide you with the best CFO expertise, call us today at 905-845-6633 or connect with us online to schedule your initial consultation.