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Optimise Working Capital: What is Working Capital?

To order to understand how to optimise working capital, we need to understand what is working capital.

Working capital is calculated as current assets less current liabilities. This amount is available to fund your day-to-day business activities.

Work Capital = Current Assets – Current Liabilities

Current Assets – consist of cash and any other liquid assets (e.g. accounts receivable, inventory, prepaid expenses)

Current Liabilities – consist of any short term finance repaymentd, expenses (e.g. salary, rental), tax and accounts payable. In simple terms, any payments that are due within one year.

Why Optimise Working Capital?

By optimising working capital, businesses can get access to more cash that can give a boost to the company’s revenue.

Below are a few of the most basic reasons why SMEs should monitor and optimise working capital carefully.

Below extracted from Capgemini Blog – Working Capital Optimization – What’s it All About?

  • Invoice-to-pay cycle: 60-120 days (approximately)
  • Early payment remains a dream, as most invoices get stuck in internal approvals by the time they get to accounts payable
  • 20 – 40 percent of invoices involve exception processing
  • According to the results of a new study from REL Consulting, a division of The Hackett Group, Inc., typical companies potentially miss quarterly working capital forecasts (including inventory, receivables, and payables) by up to 23 percent, which amounts to up to $600 million for a typical Global 1000 company (with $29 billion annual revenue).
  • Typically, a Fortune 100 company could generate nearly $2 billion in additional cash annually by optimizing working capital management to match the performance of leading companies in their industry.
  • By optimizing working capital, the typical Fortune 1000 company would have an opportunity to net over $680 million from optimizing receivables, over $620 million from payables, and over $680 billion from inventory.

Common Issues and How to Optimise Working Capital

working capital, optimise working capital, invoice finance, improve DSO, DSO

EY, Asia Consumer Products Forum, March 2014

Measurement

Description

How to optimise working capital?

Long Days of Sales Outstanding (DSO) DSO is simply how long it takes for business to get paid.If business has large DSO, this means their working capital is tied up in their accounts receivable where it could be utilised in other parts of the business Reduce DSO, (turns sales into cash as quick as possible), some of our tips:

  1. Shorten credit terms
  2. Deploy effective collection process
  3. Implement incentive scheme for early payments
  4. Invoice financing

Read more here.

Long Inventory Outstanding (DIO) DIO is the duration for inventory to turn into sales / cash flow
If business has large DIO, this means their working capital is tied up in their inventory where it could be utilise in other parts of the business
Reduce DIO, (turns inventory into cash as quick as possible) some of our tips:

  1. Better control at inventory management
  2. Look for alternative suppliers who can deliver in a shorter timescale or in smaller quantities so that SMEs do not have to hold large inventory
  3. Clearance promotions for older items
Short Payables Outstanding (DPO) DPO is number of days that business takes to pay their invoices to trade creditors (cash outflow).
If business has a small DPO, this means that cash is leaving the company sooner.
Extend DPO (prolong cash within the business)This point is usually a bit more difficult for SMEs to negotiate due to their limited bargaining power. Nevertheless, SMEs can try to:

  1. Negotiate contract for better (longer) terms
  2. Purchase financing (opt for a financial solution to finance inventory)

By optimising accounts receivable and accounts payable and cash management, additional working capital can be utilised to generate further revenue for businesses.

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