How to manage working capital and improve cashflow in your business

“Cash is the lifeblood of any business.” We’ve heard it so many times and it’s true – your business cannot operate without cash. Understanding how cash flows in and out of your business is crucial in running and growing your business.

On episode 2 of our 3-part B2B Financial MasterClass series, Lali Wiratunga, National Manager at Westpac’s Davidson Institute, shared with us the fundamentals of understanding cash flow, where cash hides in your business and how you can improve cash flow using visual tools.

Here are the key takeaways from the session.

The basics of cashflow: the cashflow budget and working capital cycle

The cashflow budget

Before we plan on how to improve cash flow, you need to understand the basis of cash in and cash out in your business. Creating a cash flow budget will help you estimate the cash coming in and out of your business, and reveal your ending cash position which can either be positive, neutral or negative cash flows.

A positive cash flow can be spent, saved or invested. A neutral cash flow means you don’t need extra funding but there’s also a limit to save or invest your money. A negative cash flow indicates that you need to find the cash to keep your business running.

Knowing your cash position will be a key driver of the initiatives you’ll take in your business. But you’ll also need to know the speed of your cash flow (i.e. the timing of your inflows to fund your outflows).

Understanding the working capital cycle

The working capital cycle helps you determine how long your money will come back into the business. The cycle begins from when cash gets added to your business, then to when you use it to spend on stock or work in progress (for service businesses), and when you receive money back from payments or receivables which starts the cycle all over again. 

The faster you turn the cycle, the more cash you will have available to you, allowing you to grow more rapidly, reduce the risk and cost of using short-term debt, and potentially improve your profit. 

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How to improve your cashflow?

So we now know how cash flows and that if your work capital cycle slows down, it can cause your cash to hide instead of flowing. Now we need to work out how many and how to get your cash flowing again.

To do this, we are going to look at each element of the work capital cycle, stop work in progress and debtors, and the actions you can take to improve cash flow.

1. Review your stock pool to improve cashflow

What is a stock pool?

The stock pool is a brainstorming tool to help you identify where you may be able to free out cash. The stock is like a big swimming pool where all your stock sitting. To fill out the swimming pool with stock, you need to purchase it. Conversely, emptying the pool means you have to sell the stock as quickly as possible.

How does the stock pool help visualize the cashflow cycle improvement?

If your stock pool is getting larger and chewing up much of your cash, you need to start working on how to shrink. To shrink your stock, you have two options. You can either slow down purchases or you can speed up sales.

Tips to improve cashflow using your stocks:

1. Slow down purchases

Reviewing your stock pool helps you think about how to reduce purchases and get to as close as possible as just in time. You can look at the following items:

1. Look at your product mix –Which items are turning over quickly, and which ones are slower. Is the slow-moving stock worth the cost of holding it?
2. Review your stock management system – Can you improve that system? Does it provide you with accurate and timely information? Do you do stock takes and match them to the system to maintain it accuracy? Do you receive alerts when it’s time to order more stock?
3. Pipeline management – Does your pipeline management help you make more accurate purchases?  Think through your purchase forecast, particularly in highly seasonal businesses.

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4. Buy less, more often – Also consider buying less, but more often while a discount on bulk purchases may seem attractive, is it enough to outweigh the cost of storing the stock that bulky stock and having your cash tied up until such time as you can sell it
5. Don’t buy – a temporary solution to quickly reduce stock. This is simply to stop buying it for a short period of time.

2. Speed up sales

The other side of the equation is to increase the outflow by improving sales. And you can do this by the following initiatives:

1. Incentivise – Incentivise your customers to buy more often by offering them a discount. Another is incentivising your staff to sell more by offering commissions, bonuses, or perhaps even offering additional sales training.
2. Review your marketing strategies – consider when whether your marketing is effective, and whether perhaps you may need to try something different. You could also try packaging slow-moving stock with a product that does sell well or try selling with a different market.
3. Donate it to charity – if none of these things is working for you and you’re still holding onto this stock, maybe you could see if you could donate it to a charity or a local school that will give you a little bit of goodwill or even PR in your community.
4. Write-off – And at the end of the day, you might be forced to write it off, and if so, write it off sooner rather than writing it off later. But of course, talk to your advisors for further information about your circumstances.

2. Review your WIP pool to improve cashflow

What is a Work-in-Progress (WIP) pool?

A variation of the stock pool is the WIP pool for service business. In this case the work-in-progress (WIP) pool is like a big swimming pool where all current jobs you need to complete is sitting. To fill out the swimming pool with jobs, you need to have the right skills. Conversely, emptying the pool means you have to get the invoices out to collect cash as soon as possible.

How does the stock pool help visualize the cashflow cycle improvement?

What this tool help visualise is having the right amount of resources to complete jobs in the fastest time possible, and you’re usually paying for the time, so you have access to resources.

Tips to improve cashflow using jobs or WIPs:

1. Ensure you have the skills and time to complete the job

Reviewing your stock pool helps you think about how to improve skills to do jobs effectively and the time it takes to complete them.

1. Pipeline management system in place – gives you a good indication of the jobs coming up and skills, people, functions, and other equipment you might need to complete those jobs.
2. Hire the right staff – hire the right number of people with a required skills, attributes, capabilities,
3. Temporary hires – Can you use part-time or casual contractors instead of full-time employees? This allows you to increase and decrease resources as the demand for jobs changes.
4. Capacity – Do you know the capacity constraints of your resources? That is how much work they can actually produce and in what timeframe. This also includes equipment and technology you use to complete jobs.
5. Reduce unproductive work – ensure the work being undertaken is productive (i.e. income-generating tasks) and ensuring admin or minute tasks are minimised.
6. Reduce excess resources – are you ensuring you’re not carrying excess staff or equipment and that’s all about making sure you keep your employees and your equipment  busy and occupied on revenue generating activities.

2. Invoice customers as soon as possible

Invoice your customers as soon as possible by ensuring you can complete jobs on the agreed timeframe. And you can do this by the following initiatives:

1. Efficient process – First and foremost, we want to finish every job as soon as we can. You need to ensure your processes are efficient and that technology is in place to streamline work.
2. Motivated employees– Ensure your employees are motivated and productive to do quality work efficiently.
   
3. Identify bottlenecks –  are there obstacles or bottlenecks that are hampering the completion of jobs?
4. Monitoring of progress – Is there process monitoring in place so you know what stage your jobs are at and you get early warning when they may get off track?

3. Review the debtor pool to improve cashflow

What is a debtor pool?

Another variation of the previous visualisation cash flow pools is the debtor pool. You can fill up the pool by making credit sales and empty it by collecting the cash from your customer.

How does the debtor pool help visualize the cashflow cycle improvement?

What this tool help visualise is how you can streamline credit sales and collect payment from those sales as quickly as possible. The debtor pool is of importance for B2B transactions as extending credit terms are a norm.

Tips to improve cashflow by using debtor information:

1. Streamline credit sales

An efficient credit sales process will ensure you get started on the right track to avoid any disputes in your transactions with your debtors. Here’s how:

1. Have a credit policy – You are essentially lending your customers the money to buy your goods and services, so it’s crucial to have a clear credit policy on the credit application boarding.
2. Reference checks and credit score reviews – Who are you prepared to lend that money to, and what criteria do they need to meet? This may mean that the new customers need to establish a good track record with you or have a good business credit score before you offer them credit terms.
3. Invoice or payment terms – You also need to consider how much you’re prepared to lend and how long before you receive payment. Your credit terms can include deposit requirements, progress payments, payment options, and whether you want to be paid in increments of 7 30, 45 days.
4. Invoice the same day –  your invoice needs to be issued the same day as you provide the goods or service. Don’t further delay your collection period by not issuing invoices promptly.

2. Improve efficiency of accounts receivable collections

 Once you have money out there, you need to ensure the systems and procedures are in place to collect those invoices in line with your terms. Here are a few tips:

1. Invoice reminders – Do you have a reminder system or accounts receivable communication workflow to remind clients of invoices as the due date approaches?
2. Follow-up with debtors – Additionally, do you have the AR automation system to follow up with overdue invoices? Ensure you can follow up using various channels – phone, email and SMS. Persistent follow-ups will likely get you paid.
3. Offer discounts –  offer a discount in incentivising people that pay earlier or those that sign up for payment options such as direct debit.

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4. Develop contact with the right person, particularly when dealing with large organisations – You need to be following up with the decision maker, not just the processor of payments.
5. Keep an aged debtor list – keeping an aged debtor listing helps you stay on top of who is paying you and who isn’t. AR automation software can help you keep track of overdue debtors efficiently.
6. Outsource collections – You could also consider using an external debt collection agency or a third-party ‘Buy Now, Pay Later’ (BNPL) financing partner to help your clients pay you in instalments.

Manage your cash flow with AR automation

The key to managing cash flow? Ensuring you get the cash back into your business as soon as possible. Understanding how cash goes in and out of your business and monitoring the cash flow cycle regularly will give you the information you need to plan for a healthier cash flow.

AR automation software can help you manage your cash flow, so you can focus on what you do best – growing your business. Speak with one of our AR experts today to learn about options for your business.