What’s Working Capital & How to Optimise It

In order to fully grasp working capital, you need to comprehend the connected concepts of cash flow and liquidity as well.

Cash flow

The net amount of cash and its equivalents moving into and out of the company's budget is called cash flow. It's about how a company generates income, such as sales, expenses, payroll, and taxes. Having positive cash flow indicates that a company is financially healthy and has solid financial operations to cover its immediate and future needs.

Liquidity

Liquidity refers to the ability of a company to convert its assets into cash quickly without diminishing its value. It indicates a company's readiness to meet short-term obligations, such as paying suppliers, creditors, and employees. Liquidity metrics, called ratios, compare a company's assets - cash, receivables, and inventory - to its liabilities - payables, expenses, and short-term debt. When the liquidity ratio is high, there are more assets than liabilities, which is again indicative of healthy operations and financial health.

Working capital is the difference between current assets and current liabilities (obligations due within the next 12 months, running operating costs, and debt repayments). In other words, it's the money the business has on hand to run its day-to-day operations. To optimize working capital, a CFO must control the balance between incomings and outgoings, ensuring there's enough funds to satisfy short-term operating costs and debt obligations at all times.

At the moment, the economic climate is quite turbulent, there is less funding available from external sources, and customers are spending less money. Managing and optimising working capital effectively can ease immediate pressure and shift the focus to growth once economic conditions improve. Having access to liquid cash gives you both stability and a competitive edge in uncertain times.

Companies with free cash are more likely to invest in growth - attract new customers, launch new products, or attract investors who see companies with better working capital as less risky.

Finally, borrowing money today is more expensive, so repayments will likely hurt you more in the long run. By gaining better access to working capital, your business can rely less on external funding.

Although working capital focuses on short-term assets and liabilities, it does not address the business's long-term financial health. For a business to maintain financial stability over the long term, forecasting is a must, as it can prepare for internal and external fluctuations.

As you make sure the company utilizes its financial resources efficiently, you will also optimize its working capital. Here are some basic financial operations improvements you could make:

Enhancing your accounts receivable process so that payments are received immediately after sales are made

Setting better payment terms with suppliers, such as extending Days Payable Outstanding by paying the supplier later, as this generates free cash flow. Alternatively, you can reduce the cost of goods sold by paying bills early and increase net income by taking advantage of early payment discounts.

Minimize overspending by monitoring spending and outflows

Diversify liquidity risk

Today's financial operations technology can significantly increase the efficiency of managing your working capital.

Here are some features of financial operations platforms, like Fyorin, that you can use to manage and improve access to your working capital:

Complete view of your treasury through a unified treasury dashboard
A single platform will allow you to see all your cash across all currencies and institutions, so you can better understand where the money is, where it is spent, and where it is coming from. Unfortunately, many businesses are operating with dispersed financial systems that cause blind spots in treasury management, making it impossible to optimize available capital effectively. Better visibility allows you to spot trends and review spending - for instance, if your business makes a lot of payments to one supplier, you may be able to negotiate better terms with them.

Diversified payments options
Using a platform that gives you access to multiple payment rails, as well as cards gives you a better option to pay with the supplier’s preferred payment method and expedite payments faster. FX and fees may apply when using traditional banking methods for payments, and suppliers may not receive the exact amount invoiced. With a good cross-border payments system, you can send B2B global payments with local payment rails and lower costs as well as maintain good relationships with your suppliers. Additionally, having access to cards can unlock more working capital by giving your team better payment terms and rebates.

Automated payables & receivables
Automated accounts payable reduce fraud risk and prevent duplicate or erroneous payments. As a result of streamlined workflow, from receiving bills to payment to reconciliation, payment cycles are accelerated giving Treasury more options to grow working capital. Using scheduled payments or partial payments you can also ensure the arrival of payments at the due date or extend the DPO.
By integrating ERPs and accounting tools, you can see all bills and dues in one place and understand your cash flow better.
For receivables, automating the reconciliation of incoming funds and segregating them into separate accounts can help you get a real-time view of revenue and insights into which areas of business are most profitable.

Payables financing
Buyers generally prefer to pay late, while suppliers prefer to receive their money as soon as possible. In payables financing, a third-party funder pays the supplier as soon as the invoices are received, and the buyer pays it back later.

Diversification of liquidity risk and lowering down the FX exposure
The diversification of liquidity risk lowers the overall business risk and spreads funds across multiple institutions and currencies, so that even if an issue arises with a particular institution or currency, business operations can continue uninterrupted.

Fyorin’s comprehensive financial operations platform provides all those tools to help you optimise working capital. Send us an email to [email protected] to see how we can help you.