Managing Cash Flow : The Importance of Working Capital – August 2014

This topic concerns financial management.

One of the CFO’s crucial functions is to provide effective cash management for the firm. A major component of cash management is working capital management, which is critical for inventory and receivable heavy companies such as retailers, wholesalers, resellers, distributors, and manufacturers.

Quick cash fixes can often be harmful to firms, causing undue pressure on employees, damaging relations, with customers and suppliers, and harming long term profitability. Accordingly, effective working capital management must be focused on the underlying fundamentals and processes of working capital management.

For accounts receivable this effort entails a focus on important customer accounts as well as establishing appropriate targets and measures of success. In addition, payment terms for key customers should be analyzed with the customer’s structure and business model in mind. This focus is supported by reducing reasons for customer disputes that provide an excuse for withholding payment. Internally controllable variables that can be modified to eliminate such excuses include pricing and quantity errors on invoices as well as return policies.

For inventory it is important to establish policies for fast moving items to avoid stock-outs while not accumulating excess stocks. Furthermore, the CFO needs to understand which products are slow-moving and at risk of obsolescence so that plans can be made to sell such products to avoid inventory write-downs.

In regard to suppliers, it is crucial to adjust payment terms to reflect supplier performance and increase cash flow. In addition, payment routines should be revamped. For instance, to increase vendor compliance, the CFO must eliminate early payments to vendors that provide poor service.

Implementation of these practices will require the expertise to analyze the various processes, identify areas for improvement, and quantify the results of the new practices. To achieve this a detailed implementation plan that enables resources to be focused on those areas with the quickest potential for a material return.

Establishing such structural changes will improve performance on an ongoing basis, help management accelerate the conversion of sales to cash, and continue to provide customers with unsurpassed service.

For more information see December 30, 2013.

Capitol CFO Solutions serves clients in Washington DC, Maryland, and Virginia. Please contact us for a free consultation.