Every good business owner knows that working capital is necessary to keep operations running. It is what allows the business to meet financial obligations like paying the employees, creditors and suppliers. Companies with insufficient working capital would be very likely to have issues with liquidity down the line despite having healthy profits.
Manufacturing companies, especially, require a sharp eye for monitoring and making sure working capital is in a healthy state. Supplier and production expenses usually come months before goods produced are sold to consumers. Manufacturers have working capital management plans that are designed to anticipate and solve these issues. According to the PWC Working Capital Survey, since 2016 manufacturing has fared significantly better than other industries in terms of working capital performance.
So fret not, here are five ways to keep your working capital healthy, especially at a time where many small businesses are only beginning to re-open and pick up pieces that can help restore operations.
1. Process Improvement
Being able to improve the manufacturing process is not only beneficial to your operations and working capital but also to the consumers and your brand. Developing quality products to consumers would also help build trust and loyalty among the consumer base. There are multiple schools of thought in improving the manufacturing process, however many of them have the same goals, which are: to optimize production through waste identification and reduction. Two of the more commonly known philosophies are Six Sigma and Lean.
Lean manufacturing or lean production, based on Toyota’s production system, is a methodology that focuses on reducing waste and unnecessary cost while maximizing productivity in manufacturing.
As such, when lean management is in place and working properly less financial resources are required in the manufacturing of goods. Lean identifies several areas of waste to consider and improve on:
Six Sigma, on the other hand, reduces waste and identifies defects like anything that isn’t up to customer expectation. It was introduced in the 1980’s by one of Motorola’s engineers, who believed that reducing variation will improve customer satisfaction and savings. Six Sigma makes use of the DMAIC process, a data-driven improvement cycle. The DMAIC consists of several steps:
These are just some ways of identifying and improving the production process. However, reducing costs might not be enough to maintain positive cash flow.
2. Manage Inventory
In line with the lean process improvement, good inventory management can also positively impact a healthy working capital for manufacturers. Production plans and orders must be put under scrutiny. Usually, businesses have several steps for managing their inventory better. To help keep their working capital healthy, manufacturers have to make sure that demand forecasting is as accurate as it could be. Being able to know how much to produce and when to produce it is key to keeping working capital at a healthy level because this ensures goods are sold as soon as possible and not just idle. Businesses want to avoid under-stocking, as well as over-stocking. To mitigate this, many manufacturers apply a Just-In-Time (JIT) inventory management system, also prescribed by the Toyota Production System. It creates efficiencies by reducing inventory space needed and reducing the risk of damaged stock. Having too much stock means cost for physical storage, as well as insurance will definitely move up. The JIT inventory system is synonymous with Motorola’s short-cycle manufacturing and IBM’s continuous-flow manufacturing. This system does, however, come with its own risks. Untoward incidents that hamper supply chain will definitely affect companies that follow a JIT system more. These however, can be mitigated by contingency planning, or quicker, if the company had an electronic resource planning system.
3. Receivables Collection
The ability to collect receivables at a faster rate is also very important to keeping a healthy working capital because cash flows are significantly improved. It ensures that money keeps coming in and payment is on time.
Automating tracking and monitoring of accounts receivable would let the business know inflows much better. A good forecasting model of cash receipts would be very beneficial to mitigating uncertainty in the business, allowing working capital usage to be planned much more efficiently.
Prompt invoicing can help quicken the receivables processing, as well as payment reminders. Some businesses would choose to offer discounts for early payments or fines for ones that are late. Sometimes flexibility, in the form of direct debiting for big clients and prepayment options, is key to keeping the capital healthy in terms of receivable collections. However, if this is an issue, short-term financing like First Circle can help fill the gap between payments.
Accounts payable can become a huge drain to the working capital source for manufacturing companies. Suppliers expect to be paid on-time and thus this can make a significant reduction in the amount of working capital available.
Paying vendors on time also allows the company to reduce days payable outstanding. Generally, timely repayments are beneficial to both parties. Although, it may seem counterintuitive to maintaining the working capital of the company, paying vendors on time allows relationships to foster and build for the future.
Some companies choose to leverage the good standing relationship by negotiating with their suppliers and vendors for better payment terms and timelines. This may come in different forms such as having payments over a longer duration, paying later, buying in volume or having discounted prices for paying up-front. Keeping suppliers happy is a move for the long run; allowing for better leverage in getting larger discounts for bulk purchases and recurring orders.
5. Debt Obligations
The cost of capital is increasing and thus companies must ensure that they are using financial products wisely and sustainably. Paying-off loans on-time when they mature is imperative to keeping working capital healthy. Delayed payments can build up significantly and come with debilitating penalties.
There are many types of financial products out there. Choosing the best one with the most reasonable payment and interest terms is very important. Understanding each type of working capital loan is important as it may make or break the health of the company.
These are just some ways to preserve and improve the health of a company’s working capital. A healthy working capital allows the business to ensure that day-to-day expenses can be covered after short-term liabilities have been settled.
To learn more about how to augment your working capital and when to do so check out our other blog posts.
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