Improving Working Capital Can Improve Your Business

April 2019

Improving Working Capital Can Improve Your Business

The importance of Working Capital Optimization is simple math: if as a business you have more cash available, you have more freedom to realize your business’s strategic goals. Whether you plan to build on your workforce’s knowledge, invest in your business’s innovation or modernization, additional free liquidity will help your business reach your goals faster. By freeing cash currently trapped in illiquid assets, such as accounts receivable, your business also becomes more independent from outside financing.

Working Capital – A Proxy for the Necessary Liquidity

The working capital of a company is usually defined as the sum of inventories/work in progress and receivables, both as stated on the balance sheet, minus payables, also as stated on the balance sheet.

Generally speaking, working capital is therefore a proxy for the liquidity that is needed (or bound) in order to be able to run the company’s business. For the sake of clarification, it must be added that this article only considers the standard approach to working capital for a company and will not address special cases or industries where the reliance on working capital may be treated significantly differently.

Working Capital Optimization – A Strategic Goal

As liquidity or capital is a scarce production factor that should be used effectively and efficiently, improving (or reducing) working capital is very often one of the strategic goals of a company. Not only does Working Capital Optimization reduce the need for, and therefore the absolute cost of, capital of a company, it also frees up cash that can be used otherwise, e.g. for investments, acquisitions or to reduce debt. Companies, hence, usually spend a fair amount of time and resources on finding ways as to how to reduce their working capital.

Working Capital Optimization Measures

Today, common measures include:

  • The reduction of inventories by improved production and logistics processes
  • Reduced payment terms with customers or – at least – changes in the dunning process in order to reduce the number of overdue receivables
  • Extended payment terms with suppliers in order to increase the accounts payable

Third Party Solutions For Working Capital Optimization

Given that all these measures come at certain costs (e.g. stability, threats to the customer relationship, increased financial pressure on the suppliers, etc.), companies are often looking for third party support in reaching their goals.

Platforms for Working Capital Finance or Optimization can provide such support. On one hand they allow corporate customers to reduce their receivables by selling them to banks or non-bank investors. They can also help to increase the corporates’ payment terms (and therefore their payables) with their suppliers, while simultaneously offering the suppliers early payment – featuring attractive financing conditions. This is done by selling their invoices to banks and non-bank investors on the platform.

Ultimately, using specialized third-party solutions for optimizing working capital can help these companies reach their internal goals by optimally using their scarce resources. This allows them to focus their attention to those things that really matter to them.