The thought that a company with sufficient assets and adequate profitability would have a satisfactory liquidity position may be illusionary.
Businesses often fail to utilize the Net Working Capital (NWC) efficiently. Management teams typically prioritize the profit and loss (P&L) statement above the balance sheet, and relatively few companies manage their liquidity with the same rigor as they manage their expenses.
A Company’s liquidity strength is determined by its ability to convert its assets to cash quickly, and that’s why efficient Working Capital Management is essential.
Working Capital = Current Assets – Current Liabilities
The Current and Quick ratio’s higher than 1 indicates an overall Heathy company.
Working capital is the lifeblood of every company and is needed for it to run smoothly. It is critical to control the relationship between a company’s short-term assets and short-term liabilities in order to maximize working capital needs.
A Structured approach to NWC
NWC optimization necessarily requires a systematic approach that focuses on accounts receivable, accounts payable, and inventory systems. In their search for improvement, companies that succeed at NWC management leave no stone unturned.
Seven phases can aid this journey.
- Design strategies to optimize net working capital levels
- Review receivables and payable credit periods and policies
- Mark the momentum of idle cash staying in the business
- Identify and prioritize to have assets easily liquidated
- Seek more liberal purchase contracts to get more short-term fiscal space
- Improvise cash conversion cycle by optimizing credit control policies and deals
- Monitor inventories to minimize obsolescence and slow movements
Don’t leave any money on the table
Successful businesses understand the value of professional cash management in strengthening the balance sheet. Improving the cash conversion period provides instant liquidity to finance more transformative projects, boosts enterprise equity, enhances credit rating, and improves efficiency.
Since NWC touches every aspect of a company, there are almost always opportunities to improve receivables, payables, and inventory. However, there is no one-size-fits-all approach to NWC optimization.