Tuesday, 20 April 2010

Improve Cash Flow - Part 2 of 2

Previously we looked at generating cash from operations, capital expenditure and financing.  Here, we look at working capital.  This is a measure of the operating efficiency and liquidity of a business.

Working capital is the difference between current assets and current liabilities.  In other words the amount of cash required to finance inventory and trade receivables net of trade payables.  Cash tied up in inventory or money owed by customers cannot be used to pay short-term obligations, and therefore businesses need to release cash from these sources where possible.

Minimize inventory levels.
There are many methods of inventory management.  A well known technique is JIT ("just-in-time"), used mainly in manufacturing.   Goods are produced only to meet customer demand.  All inventory arrives from suppliers just in time for the next stage in the production process.  This technique minimizes inventory levels.

Minimize and control cash owed by customers.
It is important to follow procedures and be organized in collecting customer debts.  

Maximize the payment period to suppliers.
Delaying payments to suppliers will not generate cash but it will delay its outflow.  Many businesses use supplier credit as a source of finance.  Large and powerful customers are often accused of dictating extended payment terms, which add pressure to a small business's cash flow.  Extended credit should be negotiated as opposed to taken, to avoid problems in the future.  Businesses rely on their suppliers to keep their operations flowing, so payment terms should always be agreed in advance.

"Creditors have better memories than debtors; creditors are a superstitious sect, great observers of set days and times!"

Release working capital to pay short-term obligations.

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