Finding a way to increase working capital helps build a long-term sustainable income stream for SMEs, especially if you offer professional services. Read on to discover how to go about improving your working capital.
What is working capital?
To help you understand working capital, we have compiled a handy guide. The main thing to remember is that working capital is not profit, but the cash your business needs to pay its bills and meet day-to-day expenses.
It’s really important to know exactly where you stand with your working capital at all times and, as shown later in the article, this means doing some simple but important maths. You derive your working capital running total by taking away what you owe (your current liabilities) from your current assets. A positive number means you have enough cash to cover short-term expenses and debts; a negative number means you’re not making ends meet and, ultimately, your business could fail. For example, if a business owner has £50,000 cash in the bank, owes £5,000 to suppliers and £10,000 in salaries, their net working capital is £35,000.
Any increase in working capital leads to a more sustainable business model. Below we outline several tactics to help you, some or all of which might be relevant to your business. How you decide to increase working capital depends on several factors, including your willingness to take on debt or invest in automated systems.
Here’s how to improve working capital in 9 ways
1. Keep your net working capital (NWC) ratio in check
Perform this calculation as soon as possible:
your working capital ratio = current assets divided by all your current liabilities
If you do this calculation for your business and get a score of 1 or less, you’re very close to full use of your capital. In other words, if you experience any business disruptions, you could face some difficulty. Meanwhile, scoring 2 or higher also suggests you’re not operating with total efficiency, which could be limiting your growth.
Demonstrating operational efficiency is the best way to get business financing and improve your working capital position. Some experts recommend trying to attain a constant 1.5, but there is no perfect score – just a rule that scores below 1 or above 2 should be avoided.
2. Improve inventory management
Never use your working capital to pay for fixed assets, as this can quickly drain your cash reserves and negatively affect how your business is viewed externally. Avoid stockpiling inventory as it’s a key part of the working capital equation: the more inventory you hold, the lower your working capital.
3. Manage your expenses better to optimise cash flow
You must keep on top of your cash flow. Your outgoings should closely track what’s coming into the business. Be aware of the lag between purchasing an essential piece of equipment and any long payment cycles for goods or services you’ve supplied. An easy way to improve your expenses management is to offset any delayed payments with the American Express® Business Gold Card, which offers payment terms up to 54 days, allowing your cash flow to stay healthy while waiting for payments to hit your account¹.
4. Automate processes for your business financing
As well as accessing faster and easier customer payment cycles, automation reduces credit control admin.
Transparency of your payment flows is vital for tracking late-paying customers who drain your working capital. Automation makes the monitoring process simple, and there are now many accounting packages, such as QuickBooks. Invoice software can shave days off the average time it takes to collect payments, helping to optimise cash flow and improve working capital.
Many SME invoicing software solutions have automated dashboards as a centralised payment portal to keep track of your invoices in one place and speed up your collection process. By using your American Express Business Gold Card to pay for software that can automate key processes, you can earn Membership Rewards® points. These can then be used towards business purchases from one of our participating retailers².
5. Facilitate early payments
Try to collect payments for goods and services within the agreed payment terms, but avoid setting terms that are so short that they jeopardise valued client or supplier relationships. If you need to receive payment more quickly, consider using invoice factoring. This approach allows funds to be raised through selling unpaid invoices to a specialist third party, thereby releasing cash in accounts receivables and working capital.
6. Make late payments rare
Be transparent with your clients that you reserve the right to enforce a late payment charge if necessary. Insert a standard clause in your T&Cs explaining why this is imperative to your business.
7. Work with vendors offering the best deals and discounts
Establish mutual trust and a reputation for fair dealing with main suppliers from the start, so there’s room for manoeuvre if things get difficult for either party. Securing a friends-and-family rate will, for example, curb your costs at the start and allow you some working capital headroom if you experience any unexpected difficulties. But once you agree on terms, stick to them! If you don’t, your chances of renegotiating to protect your working capital later won’t be as high.
8. Borrow to increase working capital directly
Long-term credit lines let you invest and grow your company without depleting your cash position. Do your research and read the small print before you choose this route – high-interest repayments can erode your capital over time.
9. Investigate tax incentives open to your company
There may be tax options that could save you money to put straight back into improving your business’ working capital. The Government’s Enterprise Investment Scheme (EIS) can raise money for your company by offering tax relief to individual investors who buy new shares in your company [1].
Or the Seed Enterprise Investment Scheme (SEIS) could net up to £5 million each year and a maximum of £12 million in your company’s lifetime [2].
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you’d prefer a Card with no annual fee, rewards or other features, an alternative option is available- the Business Basic Card.
2. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
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