Skip to main content
Managing a company's working capital assets ensures adequate cash for operations and prevents losses through late payments and obsolescence.

Cash is the life blood of any business. Particularly, as an entrepreneur you always want to be able to purchase and or replenish stock, pay salaries and ensure other administrative expenses are handled in a timely manner.

How can you accomplish this? Know your cash conversion cycle. This is a calculation used to measure the time frame from investment in inventory to sales to the collection of accounts receivable (where applicable) and back into cash.

Understanding this cycle can help prevent the business from having assets on their books (inventory and accounts receivable), but insufficient cash to pay the bills. Managing a company’s working capital assets ensures adequate cash for operations and prevents losses through late payments and obsolescence.

Read on to learn how you can achieve this.

1. Manage your Cash Flow

Ideally, businesses should have cash in the bank to cover known expenses as they become due, as well as contingency funds to cover unforeseen expenses.

The recommended asset to liability ratio is 2:1 – i.e. current assets (cash, accounts receivable and inventory) should be twice the value of current liabilities (accounts payable and current portion of long term debt).In fact, having a cash flow surplus on a sustainable basis is essential to growing your business.

Using this ratio, assess your cash flow on a regular basis to ensure a healthy cash position — or at least provide management with early signals of financial strain.

In instances where the cash flow forecast shows a surplus during certain periods of the year, it is prudent to put those funds to work. For cash surpluses consider the following options pending re-investment in the business or distribution to shareholders:

  • Short-term (seasonal or cyclical cash flow surplus) – consider overnight investments, such as local and foreign currency savings account, money market accounts, or call deposits as options for earning interest on extra cash.
  • Medium Term – (longer term or core cash surplus) – consider, medium-term investments such as income or income and growth funds, certificates of deposits or equities or bonds.

2. Examine your Accounts Receivables

Accounts Receivable (AR) refers to the money that a company has to collect from the sale of goods and/or services to customers on credit. As these funds are owed to the business, they are treated as an asset on the company’s balance sheet. And as with all debts, the business must be concerned about the timeliness and likelihood of collection of all of these monies. Managing AR is therefore critical to ensuring the business has a cash flow that can be relied on to meet its expenses.

Some questions to consider are:

  • What are the eligibility criteria for extending credit to clients or potential clients?
  • Who owes money?
  • How much is owed?
  • When is the money due?
  • What credit policies and systems are in place to govern AR?
  • What collections procedures does the company have in place?

Without proper oversight and control of AR, the operation of the business can be severely impaired and the profits of a business can be easily eroded.

Hints to effectively manage AR:

Step 1: Maintain healthy customer relationships. Being able to have a conversation and cite previous agreements can help you collect faster.

Step 2: Reach out to your customers (by phone or letter) about past due balances. Do this on a regular basis, and don’t wait too long – connect with them as soon as they exceed the payment terms.

Step 3: Offer installment payment options. In you’re waiting for a large payment to come in, consider breaking up the bill into more manageable segments. Getting some cash in now can be better than nothing.

3. Maintain Inventory Quality and Level

In a retail or wholesale trade, inventory management is critical. Having the correct quality of goods in the correct quantities for resale at the right price is important to build and maintain a loyal client base.

Avoid tying up capital by holding on to excess inventory, and running the risk of obsolescence or spoilage – that is, the goods become outdated or spoil before they can be sold.

Consider the following for inventory control:

  • What type of inventory does the business carry – Raw materials? Work in progress? Finished goods?
  • What percentage of inventory is considered perishable?
  • Is there obsolete inventory, slow moving inventory, for which there is little or no value?
  • What is the realizable value of the inventory?
  • What is the company’s liquidation strategy for obsolete inventory?

It is also recommended that a business implements a First In, First Out (FIFO) strategy. This will ensure that older stock is used up first, so nothing sits on the shelf too long. Even if you don’t work with perishables, keep in mind that packaging, colours and styles change over time, so even basic merchandise can become obsolete if left too long in the warehouse.

4. Monitor Accounts Payable

Accounts Payable (AP) represents money owed to suppliers for materials/goods purchased and appears as a liability on the company’s balance sheet. Having internal control of AP is the counter balance to proper cash flow management.

Businesses must ensure that expenses are paid when due. Late payment of bills can have an adverse effect on the company’s reputation and credit rating, as well as negatively affect business operations if it is unable to order more raw materials or goods due to monies owed to suppliers. Resist the temptation to pay bills well in advance of the due date unless there is a benefit – such as a discount for early payment –attached.

Items to consider include:

  • What is approved the credit repayment term on the AP item?
  • How does the age of the payables compare with the credit terms?
  • Are these payments processed in a timely manner?

5. In the Event of Shortfall, Consider Working Capital Solutions

Working Capital financing is meant to address the short-fall in the client’s operating cycle – the gap in time between the conversion to cash of Accounts Receivable and Inventory, and the payment of bills as they become due.

Financial Institutions, including banks, offer working capital financing solutions to their clients to provide them with access to funds to meet Accounts Payable on a timely basis, as needed.

These solutions are usually of a short-term nature (usually under one year), and may be of a revolving nature. Several businesses maintain such credit facilities as contingency in the event of delays in collection of AR or during slow sales cycles.

A business may wish to consider:

  • Working Capital Line – an automated revolving line of credit, providing businesses with financing to cover both predictable and unexpected needs
  • Short-term loan – a structured financing solution, allowing the business a defined repayment schedule over a period, usually less than a year.
  • Business Credit Card – a product that facilitates payment for goods and services, locally and internationally, while providing additional benefits and features.

Interested in learning more on how to manage your cash cycle and grow your business? Contact a Relationship Manager at the closest RBC Royal Bank Business Banking Unit today!