Working Capital Management When Margins Are Under Pressure
June 2020
For most businesses, the gap between profitability and cash generation is working capital — the money tied up in stock, debtors, and prepayments, offset by what the business owes to creditors. In periods of margin pressure, effective working capital management can be the difference between a business that survives and one that does not.
This article examines the key levers available to finance leaders, the common mistakes that erode working capital efficiency, and how to build the reporting and processes that keep cash flow healthy.
Understanding Your Cash Conversion Cycle
The starting point for any working capital improvement programme is understanding your cash conversion cycle: how long it takes from paying for inputs (materials, labour, stock) to receiving payment from customers. The shorter this cycle, the less working capital the business needs to fund its operations.
For a manufacturing or product business, this typically includes supplier payment terms, production lead times, stock holding periods, debtor days, and the efficiency of the invoicing and collections process. Each of these can be measured, benchmarked, and improved — but only if you have the data to understand where you are today.
Inventory: The Hidden Working Capital Drain
Inventory is frequently the largest working capital item for product businesses, and the hardest to manage well. Slow-moving or obsolete stock is cash that is not working — and in businesses where products have a seasonal or trend-driven lifecycle, the cost of holding the wrong stock can be significant.
Effective inventory management requires accurate demand forecasting, disciplined purchasing processes, and regular review of slow-moving lines. It also requires the courage to write down or dispose of stock that is not going to sell at full price — a decision that can be difficult to make but that releases cash and clarifies the true margin position of the business.
Debtor Management
Many businesses focus significant energy on winning sales and much less energy on collecting the cash those sales generate. A sale is not a sale until the cash is in the bank — and a culture that treats collections as a finance problem rather than a business-wide priority will consistently underperform on debtor days.
Best practice includes: clear credit terms agreed and communicated at the point of sale, prompt and accurate invoicing (disputes start at the invoice), proactive chasing before invoices become overdue, and escalation processes that are followed consistently. The finance function should provide the data and the process; the commercial team should own the relationships.
Supplier Terms
Supplier payment terms are a legitimate source of working capital funding — and many businesses accept the terms they are offered rather than negotiating the terms that work for their business. Extending payment terms from 30 to 60 days on your largest supplier spend can release significant cash without any impact on operations, provided it is done in a way that does not damage important supplier relationships.
For businesses in financial difficulty, early payment discounts offered by suppliers can also represent a cost-effective source of working capital improvement — but only where the discount rate is compared carefully against the cost of alternative funding.
Building a Cash Flow Forecast That Works
Effective working capital management requires a rolling cash flow forecast — not a static annual budget, but a dynamic, regularly updated view of cash inflows and outflows over the next 13 weeks and beyond. This forecast should be reviewed weekly by the CFO and discussed monthly at board level.
If your business does not currently operate with a rolling cash flow forecast, or if the forecast you have is not being used to drive decisions, this is the highest-priority improvement you can make to your financial management. We would be happy to discuss how to build one for your business.