The essentials of working capital management (1)

Cash is the life blood of any organisation:

Cash is the lifeblood of any organisation. As blood is essential for the smooth operation of our body, so is cash essential for the smooth running of business operations. Cash is an important element of working capital – money that is used for the day to running of the business. Without enough cash to meet daily, weekly or monthly needs, a business is bound to suffer. Working capital, also defined as current assets less current liabilities is a measure of liquidity. It is a financial metric that measures how quickly and easily an organisation can convert its assets into liquid cash. A favourable working capital position is represented by an excess of current assets over current liabilities and vice versa.

The company should not spend more than it has. The moment current liabilities start to increase more than the current assets should act as a warning signal to the managers that something is wrong. As evidenced by the global financial crisis of 2008-2009, the reason most companies go under or bankrupt is lack of cash. That is why it is important for the organisation to have a buffer to meet these expected and unexpected needs. Cash is really critical and the king.

Monitoring and managing payables (creditors):

Payables also known as creditors are an important part of the organisation’s working capital value. They form part of the current liabilities and thus they drain cash resources out of the business. Payables is that amount of money which the company is due to pay to its suppliers and other vendors. For example telephone bills, lighting and heating bills, insurance costs, and travelling costs.

The key here is to reduce the level of the company’s payables and increase the receivables. As payables are an important part of cash flow, care should be taken that there is no overspending which might later put the organisation in the red. As the old saying goes: “Don’t bite off more than you can’t chew”.

The following measures are essential for managing payables:

# Negotiate buying terms with your suppliers: Negotiate favourable terms with your suppliers and stick to the agreed terms, and avoid breaking them. Having a good record of on-time payment will strengthen your relationships with suppliers as well as improve your credit rating thereby allowing you to get improved trade credit terms in the future.

# Reconcile purchase quantities to demand forecasts: Don’t fall into the trap of buying raw materials or other supplies for stockpiling without first assessing the demand for those products. You don’t want to have a situation where most of your cash is tied up in stocks in the storage room.

# Take advantage of IT: IT allows for automation of payables. Enter the invoices into the system as soon you receive them and establish when they are due for payment. This will help you monitor those payables which are already ageing and need urgent treatment. Also, you will avoid souring your relationships with your suppliers due to late or non-payment of invoices.

# Shop around: It could be that you have been doing business with your suppliers for a long time and you now feel comfortable with them. However, there is no harm in comparing supplier terms as you are more likely to get competitive favourable terms from other suppliers. Avoid the trap of depending on a single supplier.

# Clarify who is responsible for purchasing decisions: Who is responsible for finalising the purchasing decision? Avoid a situation where anyone can make a decision. There should be a recognised figure responsible for finalising any purchases. This is essential as it helps ensure that all invoices are approved before any amount is paid. Also by having one or two personnel responsible for purchasing, it avoids duplication of purchases which might cost the company more money.

What else can a company do to manage its payables?

Comments and questions are welcome.

Sharing is caring:

No Comments

No comments yet.

RSS feed for comments on this post. TrackBack URI

Leave a comment

WordPress Themes