Working Capital Management: Best Practices for Businesses

Your business may seem profitable on paper, but without strong working capital management, you could be in a troubling financial position without even realizing it. That’s why your working capital management is key to business stability and growth. 

Strategic working capital management helps companies optimize assets and liabilities to maintain liquidity and efficiency. It’s kind of like making sure your fridge is stocked well enough to feed you at any given time, but not so full that food starts to spoil.

In this article, we’ll explore what working capital management is, why your business should pay attention to it and how you can use best practices to overcome the common challenges that come with managing capital.

What is working capital management?

Working capital management is the strategic process of managing a business’s current assets (think cash, accounts receivable and inventory) and current liabilities (accounts payable and short-term debt). The goal is to strike a balance between liquidity, which is the ability to quickly convert assets into cash, and operational efficiency. This way, you can use your resources wisely to help your business run smoothly.

While working capital itself—which is calculated by subtracting your current liabilities from your current assets—is a short-term snapshot of your business’s financial health and its ability to pay upcoming bills, working capital management is an ongoing process designed to help keep your working capital in good shape for the long haul. 

Through effective working capital management, you can increase your working capital, maintain the right amount of inventory and negotiate favourable payment terms with vendors and suppliers. You’ll gain a clear and strategic understanding of the controlling levers that impact cash flow when you master this process.

Why working capital management is important

Whether you’re gearing up to scale, improving operational efficiency or enhancing your financial health, implementing working capital optimization strategies offers several advantages: 

Keeps your businesses solvent and able to cover day-to-day operations  

Proactive working capital management enhances your overall business resilience, unlocking cash that would otherwise be trapped. This ensures you can pay short-term bills without issue. 

Reduces reliance on costly short-term financing 

While you can certainly leverage credit as part of effective working capital management, some short-term financing options can be costly. Working capital management ensures you have enough liquid cash available when you need it. 

Improves cash flow and positions the business for growth 

Businesses in the midst of scaling often face higher operating expenses, which can become a strain on cash flow. Working capital management helps you fund growth without incurring debt or giving up equity. It minimizes the need to borrow money from external parties. 

Enhances relationships with suppliers and lenders

In Canada, many businesses have longer payment cycles and often face supply chain constraints, which means you can’t convert receivables into cash as quickly to pay bills. Working capital management allows companies to be more agile and have access to cash at the right times. This builds trust with suppliers and lenders because they consistently see you pay bills on time (and who doesn’t love that?).

Core components of working capital management

Working capital management involves multiple business processes that you or your finance team need to undertake. It consists of four key areas: 

• Accounts receivable management: Monitoring and controlling the money owed to you, such as from customers, helps you collect payments faster as you can stay on top of any delays. 
• Accounts payable management: Track and control the money you owe to suppliers. Paying bills on time maintains strong supplier relationships and helps you manage cash flow effectively, improving liquidity management.
• Inventory management: Avoid overstocking or shortages by accurately forecasting demand. Efficient inventory management helps ensure you have the right products available without tying up too much cash in stock.
• Cash management: You need to have enough liquidity for bill payments and unexpected expenses without having too much excess idle cash that sits unused and does not serve your business.

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Common challenges in working capital management—and best practices to overcome them

Whether you’re running a startup, small business or scaling company, you already know that nothing comes easy. As a result, when going through the working capital management process, you’re bound to come up against some obstacles. Here are a few of the most common challenges and effective strategies to overcome them. 

Challenge: Customers are constantly paying late

Best practice: Your accounts receivable can get out of hand if you don’t have a strategy in place. Start by building strong customer relationships. When customers feel like they know you personally, they may be less likely to skip paying their invoices. You’re no longer just a faceless name in their accounting system! You can also implement incentives for paying within the specified payment terms. For instance, if a customer pays within 30 days, they receive a 1% discount.

Challenge: Holding excess or obsolete inventory

Best practice: Idle stock ties up cash that could be used elsewhere in your business. In addition to tightening up your demand forecasting process (more on that below!) and using a just-in-time inventory model, consider liquidating obsolete stock, repurposing inventory or recycling stock. You can also negotiate return or exchange terms with your suppliers to send back inventory that isn’t being used. 

Challenge: Seasonal fluctuations in demand

Best practice: Forecasting and budgeting are key considerations here. Your finance team needs to analyze fluctuations in demand and gain a clearer understanding of factors such as supply chain constraints. This will help you be better prepared for seasonal fluctuations so you don’t get caught off guard. Always expect the unexpected! 

Challenge: Short-term loans or credit lines add repayment pressure

Best practice: Cash flow forecasting is essential in this case, as it will help determine when you’ll have liquid cash available to pay back loans and credit lines. Look at business expenses, customer collections, vendor payments, when payroll is going to hit and other factors to determine when your company can make payments. Just like you, lenders have a business to run—and they’re not afraid to turn on the pressure.

Working capital management: A fine balance

Effective working capital management is about maintaining balance, not just having more cash in the bank. You need the right amount of cash at the right time. Not enough cash leads to unpaid bills and vendors knocking at your door, while too much cash leads to unexplored business opportunities. 

With regular monitoring and strategic adjustments, you can reduce risk and improve flexibility, competing effectively with other companies in your industry. Strong working capital management practices also help unlock cash needed for growth. This gives you much-needed stability during times of market uncertainty.

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