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C2FO Powers Early Payment Programs for the World’s Largest Companies.
Discover expert insights on working capital, cash flow optimization, supply chain management and more.
We believe all businesses can and should have equitable access to low-cost, convenient capital to grow and thrive.
Your business can leverage financial strategies to unlock working capital without taking on additional debt through working capital optimization.
Businesses are operating in a time of great economic uncertainty. As inflation rises, geopolitical instability persists and bank failures make headlines, you may be wondering: How can my small to mid-sized business stay resilient during a crisis?
In an economic downturn, the key to success is prioritizing liquidity, risk management and access to funding sources. Central to these strategies is optimizing your working capital, which generates the cash needed to operate, invest in inventory and growth, and build a safety buffer.
Working capital optimization is crucial during an economic crisis because financing from traditional lenders may become inaccessible. Banks typically restrict lending to protect their assets, which could jeopardize your funding eligibility and interfere with your buyers’ supply chain financing programs.
What is working capital optimization and how can you use it to maintain a healthy working capital position?
Working capital optimization is the process of managing current assets and liabilities to generate sufficient cash flow. Current assets include a business’s available cash, accounts receivable and inventory, while current liabilities include accounts payable and short-term debt obligations, usually over a 12-month period. Put simply, optimization strategies aim to turn working capital trapped in accounts receivable, accounts payable and inventory into cash more efficiently. This ensures that the business has enough cash flow to cover operating expenses and short-term debts.
There are several reasons why working capital optimization is crucial to success, especially during an economic crisis:
Working capital optimization focuses on three business areas: accounts receivable, accounts payable and inventory. These components make up the working capital cycle, generating cash from accounts receivable and using that cash to pay for inventory and make sales, generating cash again.
The working capital optimization cycle, often called the cash conversion cycle (CCC), measures how long it takes your business to convert inventory investments into cash. CCC is calculated using the following formula:
CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)
Here’s how to calculate each of these three metrics:
DIO = ($ Inventory / $ Cost of Goods Sold) x 365 Days
DSO = ($ Accounts Receivable / $ Total Credit Sales) x 365 Days
DPO = ($ Accounts Payable / $ Cost of Goods Sold) x 365 Days
The above formulas calculate the cycle over one year. However, you can change the number of days if you’re working with a different timeline — such as a monthly or quarterly period.
The ideal CCC number varies depending on your industry, but the goal is generally to minimize the cycle length as much as possible. A low CCC indicates that your accounts receivable and inventory are converting to cash efficiently, creating a healthy cash flow.
DIO + DSO – DPO = CCC
If your business is facing an economic crisis, there are several strategies you can use to optimize working capital.
The first step in weathering economic uncertainty is to closely monitor your financials. Forecasting cash flow over the coming weeks, months and quarters enables your business to predict cash shortages and mitigate potential risks. It will also help you build a cash reserve, maintain shareholder value and maximize growth investments if you anticipate a cash surplus. Monitoring your cash conversion cycle is a good place to start. Other key financial metrics include:
After investigating typical CCC values in your industry and performing a cash flow analysis, you may discover that your cycle is too long. By breaking down DIO, DSO and DPO, you can illuminate the source of a long cash conversion cycle: Is inventory building up because of slowing customer demand? Are your buyers taking too long to pay invoices? Or are you paying bills earlier than you need to?
While improved inventory management or marketing strategies can lower days inventory outstanding, an economic crisis can make it challenging to control this metric. You can, however, increase DPO by delaying your bill payments as long as possible before maturity. You can also shorten days sales outstanding by negotiating shorter payment terms with buyers, using early payment incentives or implementing invoicing best practices.
There may be opportunities to improve cash flow by changing your business’s invoicing practices. The sooner your buyers receive invoices — and the easier it is for them to make payments — the faster you are likely to convert accounts receivable into cash. You can use your invoices to optimize cash flow by:
An economic crisis can drastically change lender eligibility requirements and terms. Banks may also cancel other programs, such as supply chain financing, with your buyers. With supply chain financing, buyers partner with a financial institution to fund early payments to suppliers. Without this agreement in place, suppliers may suddenly have to revert back to extended payment terms with buyers, which can lead to a longer cash conversion cycle and shrinking cash flow.
To avoid any surprises, evaluate the sustainability of any supply chain financing programs that your buyers leverage. It’s also wise to revisit your relationships with any lending institutions. Assess whether you can meet evolving eligibility requirements and costs for financing should your business run into a cash shortage.
When working capital optimization strategies aren’t enough, you may need financing. However, traditional financing options such as working capital loans may be inaccessible to small to mid-sized suppliers — especially when interest rates increase and requirements get stricter. Thankfully, there are alternatives that your business can leverage.
For example, peer-to-peer (P2P) lending funds businesses without using traditional institutions. P2P platforms connect businesses with a network of lenders, often with better interest rates and more flexible requirements than banks. Asset-based lending is also more accessible to smaller businesses and those with limited credit histories. This lending type secures working capital financing against an asset to reduce risk, and often comes with better rates and terms.
You can also leverage early payment programs — which allow you to get paid faster in exchange for a small discount — to optimize working capital without taking on debt. Programs such as C2FO’s are already implemented by a large network of enterprise buyers. Suppliers simply use the online platform to view outstanding invoices, choose which ones to accelerate, set a discount rate and receive payment once the request is approved. Unlike traditional supply chain financing, these programs don’t rely on a third-party institution to function, making them sustainable during a crisis.
Traditional lenders may be the first place a small to mid-sized business goes to seek funds when an economic crisis looms. While borrowing can help your business weather fluctuating market conditions, optimizing your working capital can be a more cost-effective and accessible way to access cash. Working capital optimization enables you to convert accounts receivable and inventory assets into cash more efficiently.
The good news is that many working capital optimization strategies — such as measuring your cash position, improving your invoicing strategy and leveraging early payment programs — are solutions you can implement right now.
Learn more about early payment programs as a debt-free way to optimize your working capital.
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