How to increase working capital and keep your business agile: 6 tips
4 minutes read
Working capital is the backbone of any business, so learning how to maintain or generate more cash in your company is vital to success.
"It's basically the cash you need to operate, or your current assets minus your current liabilities. Without enough working capital, you could lose your flexibility and credibility with financial institutions, suppliers and customers," says Marie-Claude Provost, Vice President, Alberta South at BDC.
Depleting your working capital can also diminish your capacity to exploit new business opportunities. For example, Provost says, "if your competition suddenly closes up shop and you need more inventory to service their customers, you would need working capital to buy that additional inventory. Without it, you're unable to react quickly."
Keeping sufficient working capital on hand can be a major challenge for cash-strapped entrepreneurs, so remember the basics. Making sure your business gets paid for the goods and services it provides is still the most elementary way to increase working capital, notes BDC Senior Advisor, Strategy Implementation Nick Fry.
Ask yourself: How much can I afford to lend my customers without draining my working capital?
"You want to ensure that your customers have a good credit history and that they will respect your payment terms. Otherwise you may find yourself without cash when you need it," he says.
Fry recommends that entrepreneurs clearly communicate their credit policy up front. "Your clients need to know the maximum amount of credit you will grant them, payment terms—30, 45, 60 or 90 days—and deposit requirements. Ask yourself: How much can I afford to lend my customers without draining my working capital?"
1. Don’t wait until the end of the month
Collecting payments from customers faster is an obvious route to keeping more working capital in your company. Still, Fry believes it's important not to put your rapport with clients in jeopardy. "You need to keep your clients happy and attract sales, but at the same time, ensure that you're not footing the client bill too long," he says.
To help protect yourself from late payments, he recommends billing as early as possible. "You don't have to wait until the end of the month. That's a common fallacy. You need to generate an invoice as soon as the goods or services are delivered."
2. Don’t finance fixed assets with working capital
Provost discourages entrepreneurs from depleting their working capital to finance fixed assets such as equipment.
"A lot of small businesses tend to use cash to pay their debts. It's an old mentality. In the end, you would be better off using long-term loans to pay for fixed assets," she says.
When business owners use up all of their cash, they also look more risky to financial institutions. "You may lose their confidence that you're running a healthy company."
As an alternative, a long-term loan allows entrepreneurs to breathe easily and pay for assets at a set pace.
"You can easily recuperate the costs of interest on a long-term loan. For example, if you keep a good cash flow and are able to pay your suppliers quickly, you're more likely to be able to secure discounts. In turn, these discounts can partially pay the interest on your loan. Eventually, you'll get the cost of the loan back," she emphasizes.
3. Borrow to increase your working capital
Provost contends that taking on long-term debt for working capital also pays off. "You can't grow your business and increase your profits if you're not investing in your company," she says. "For instance, if you have a list of clients, you can only change them into real accounts receivables if you can afford the inventory to sell to them… It's basic business know-how."
4. Refinance your fixed assets
Entrepreneurs can also consider refinancing fixed assets such as equipment in order to generate working capital. "Basically, you're leveraging your assets and turning them into the cash that you need," says Provost. Business owners can benefit from the extra working capital to improve their plant layout, pursue new export markets or align their HR strategies.
5. Make a personal investment
Another option for business owners is to make personal investments to increase working capital. "You'll first need to do a cost/benefit analysis to see what return you will get on your investment," she explains. "This is a viable strategy if you see that the payoff in your business outweighs personal losses."
6. Get external advice
It's not always easy for entrepreneurs to see how they can improve their cash flow, so Provost recommends that business owners seek outside help.
A consultant will typically help entrepreneurs do a thorough assessment and look at key areas such as their sales cycle, inventory turnover and credit terms for suppliers and customers. They can also find areas of the business where there is room to improve and find ways to generate more cash internally.