Resources | Working Capital | December 5, 2023

What Is Working Capital Optimization?

Can’t secure or afford traditional business loans? Working capital optimization provides a debt-free way to support business operations and growth. Here’s how.

Can’t secure or afford traditional business loans? Working capital optimization provides a debt-free way to support business operations and growth. Here’s how.

At some time or another, most businesses need financial support to cover operating expenses and make growth investments. But what if your business could minimize the need for additional debt by leveraging cash values hiding within inventory and accounts receivable instead?

This is the principle behind working capital optimization, a set of practices aimed at improving your business’s financial efficiency. Considering the high cost of borrowing — and the fact that financing is often hard to get, either due to your credit history or economic pressures — working capital optimization is one of the most affordable and accessible ways to fund your business.

What is working capital optimization, and how can you effectively optimize working capital for your growing business?

What is working capital optimization?

Working capital optimization is the process of strategically managing assets and liabilities to improve cash flow and meet short-term financial obligations.

  • Assets: Cash, inventory, property, equipment and accounts receivable (AR).
  • Liabilities: Debt obligations and accounts payable.

In other words, working capital optimization encompasses techniques to convert your business’s assets — namely inventory and accounts receivable — into usable cash more efficiently. Strategies may also optimize liability expenditures, usually by reducing costs or delaying payables when possible.

AR assets are likely available for conversion if your buyers have lengthy payment terms and your business must wait extended periods for invoices to settle. This means that even if sales are high and the business is profitable, you may still lack the cash flow needed to cover operating expenses, pay off debts and grow.

Benefits of working capital optimization 

Working capital optimization improves cash flow, ensuring that your business has sufficient funds to operate and invest in growth. Additionally, working capital optimization unlocks the cash value of assets your business already owns, which minimizes the need for financing and reduces borrowing costs.

Optimizing working capital is always valuable, but it is especially important during times of economic uncertainty. During a crisis or downturn, banks often increase interest rates and restrict lending. If securing financing isn’t an option, working capital optimization could be one of your only accessible sources of cash. Rapid inflation also means that the sooner you can turn AR and inventory into cash, the more value that cash will have when investing back in the business.

Lastly, working capital optimization reflects well on your financial metrics. This attracts investors, improves shareholder value and increases your chances of getting approved for financing in the future.

Working capital optimization: 5 strategies for your business

To recap, working capital optimization converts your business’s assets into cash more efficiently. But how do you do this? Here are five common strategies to consider:

1. Monitor your cash position

Understanding your cash position is a necessary first step in optimizing working capital. It shows whether your business can comfortably operate while maintaining a buffer. Forecasting cash flow over the next several weeks and months will help you predict shortages and plan accordingly. 

Calculating the cash conversion cycle (CCC) is also a good place to start because it can help you identify the sources of financial inefficiency in your business. The CCC measures how long it takes to convert inventory investments into cash from sales. It does this by subtracting the number of days it takes to make debt payments (days payable outstanding, DPO) from the combined number of days it takes for inventory to sell (days inventory outstanding, DIO) and for buyers to settle invoices (days sales outstanding, DSO):

CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)

Analyzing these numbers can determine opportunities for working capital optimization — for example, if inventory turnover is too slow or buyers are extending payment terms beyond your means. 

Other useful financial metrics for monitoring your business’s working capital health include the cash ratio, cash flow statement and your balance sheet.

2. Renegotiate payment terms

One way to optimize working capital is to retain cash by paying invoices as late as possible within the payment terms without incurring late payment fees. In other words, make debt and other payments on the due date, and no earlier. In terms of the cash conversion cycle, extending accounts payable timelines will increase your DPO and make the cycle more efficient.

When it comes to your suppliers, consider negotiating terms that are favorable to both parties. However, remember that delaying payments impacts supplier cash flow — something you are likely aware of as a supplier yourself — and jeopardizing the financial stability of key suppliers can cause supply chain disruptions. 

3. Manage invoices strategically

Outdated, manual invoicing processes create errors, slow down AR and are more costly to complete. Digital, automated invoice management tools, however, expedite the process, generate more accurate invoices and offer multiple payment options. This not only enables faster payments but also saves your AR team time and resources. 

As with suppliers, negotiating payment terms with buyers should also be part of your working capital optimization strategy. If buyers are taking too long to pay, consider negotiating shorter terms or offering an early payment incentive. Make sure you also establish clear terms for late payments.

4. Streamline business processes

Your business can free up working capital by taking advantage of internal cost-saving opportunities. Evaluate your operations for redundant, slow or error-prone processes, and consider using technologies that can automate these tasks and provide a significant return on investment over time. For example:

  • Inventory management software: Helps optimize inventory investments by identifying slow-moving stock and predicting demand.
  • Enterprise resource planning (ERP) software: Efficiently integrates and manages business-wide processes, from finances to supply chain operations.
  • Customer relationship management (CRM) software: Manages and automates interactions with your buyers as well as sales and marketing strategies. 

As part of your working capital optimization strategy, you can also save costs by renting rather than purchasing equipment, or by contracting rather than hiring employees. If you have healthy, long-term relationships with your suppliers, you may also be able to negotiate lower prices.

5. Leverage early payment programs

Getting paid faster by your buyers is key to working capital optimization, reducing DSO and accelerating cash flow. Offering your buyers a small discount in exchange for early payment is an age-old strategy used to shorten payment timelines. However, modern early payment programs developed by fintech companies are making the process easier and more cost-effective.

These programs, such as C2FO’s Early Pay solution, are initiated by buyers. Here’s how it works from your perspective, as the supplier:

  • If any of your buyers support the program, you simply create an account and log in to view your outstanding invoices.
  • You choose which invoices to offer for early payment and determine an acceptable discount rate.
  • If the offer is accepted by your buyer(s), you receive payment — minus the discount — in as little as 24 hours.

This gives you an immediate cash flow boost, unlocking cash from accounts receivable to cover short-term expenses or growth investments. Because the only cost is the discount itself, early payment programs are often competitive with alternative working capital solutions such as business loans — but much easier to access. Compared to other early payment solutions, which include supply chain finance and invoice factoring, these programs also give you more flexibility and control over which invoices to accelerate and at what cost.

The bottom line

Working capital optimization includes a variety of strategies used to effectively manage business assets and liabilities, with the end goal of improving cash flow. These strategies generally attempt to minimize business expenses, delay accounts payable where possible and encourage faster buyer payments.

If your business is struggling to secure the financing needed for operating expenses and growth, or simply wants to maximize surplus cash, then you will most likely benefit from working capital optimization. This approach can help you avoid taking on more debt to meet your business goals — and thanks to innovative solutions such as early payment programs, it might be more accessible than you think.

Click here to learn more about optimizing your working capital through an early payment program.

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