Critical Errors in Working Capital Management Every Business Should Avoid

Every business needs healthy cash flow to run smoothly, pay bills, and grow. But, many businesses make mistakes with their working capital that can hurt their finances. This insightful guide will dissect these frequent missteps and equip you with valuable strategies to navigate them successfully.

Recognising the Indicators of Working Capital Management Issues

How can we tell if a company has a working capital issue rather than just low sales or too many expenses? A significant difference between a company’s cash flow from operations and net income is a glaring indicator of a working capital issue, even if traditional financial metrics appear healthy.

Imagine a bakery that has impressive profit margins. They get a lot of business during the holidays and make a lot of money. But most of their sales happen only during those busy months.

All that holiday cheer translates into a need for substantial short-term business financing to cover ingredient costs and staffing for the busy season. This leaves them with insufficient funds to purchase ingredients for everyday operations throughout the rest of the year. They’re stuck in a cycle of borrowing and repaying despite being profitable on paper. Their working capital situation is strained.

Inadequate Accounts Receivable

One of the biggest hurdles in business working capital management is the simple neglect of customer collections. Think of your business like a piggy bank. When you sell items, you put money in (like saving coins). But if customers don’t pay you, you forget to take money out. Then, you won’t have enough to buy what you need, like supplies or rent.

Pick someone to be the money collector, like an “accounts receivable (A/R)” person to avoid this. They keep track of how much customers owe and tell the boss how things are going with collecting money.

This person should make reports showing how old unpaid bills are and how good the business is at collecting money. By looking at these reports, the boss can be proactive and remind customers to pay.

To keep the collector motivated, you can give them a bonus for collecting a lot of money on time. You can also have them follow up with customers who are late on payments.

If many customers pay late, it might be because they have too much time to pay. Shorten the amount of time they get and charge a fee if they’re late. This will encourage them to pay timely.

Finally, it could mean you’re giving credit to customers who can’t afford to pay if you have to forgive a lot of debt. Have clear rules for who gets credit to avoid wasting money.

Inefficient Payables Management

Falling behind on bills, or what accountants call inefficient accounts payable (AP) management, can trip businesses up in a number of ways. This can materialise as blown payment deadlines, snowballing late fees, and frosty relations with suppliers. It can even lead to cash flow issues. By letting AP languish, businesses risk harming their financial well-being and smooth operations.

The good news is there are antidotes! Implementing streamlined AP practices can be a lifesaver. Think about setting clear schedules for payments, keeping a close eye on due dates, negotiating better terms with vendors, and leveraging automated payment systems. These steps can help businesses dodge these pitfalls and keep things running smoothly.

Lack of Communication and Coordination

Businesses often struggle due to a basic problem: departments not talking and working together. Here’s how this communication gap can strangle your working capital:

• Sales vs. Finance Feud: When sales and finance operate in separate bubbles, chaos erupts. Sales might push for easy credit terms to boost numbers, leaving finance scrambling to manage the cash flow crunch. But with clear communication, sales can be aware of inventory levels and adjust their pitch to avoid overstocking. Collaboration unlocks hidden gold mines – a sales team clued into realistic inventory levels can tailor their approach, preventing a cash-draining stockpiling situation.
• Blind Spots and Bottlenecks: Limited information sharing creates blind alleys. Imagine purchasing lands a fantastic deal on materials, but production remains in the dark. Those materials gather dust, tying up cash. Conversely, huge production faces unexpected demand and can’t get the materials they need because communication with purchasing is stuck in molasses. These roadblocks disrupt workflows and stall cash flow.

Conclusion

Businesses can sometimes find themselves short on cash, making it difficult to manage bills and plan ahead. This can be stressful, but there are solutions to get things back on course.

Many lenders and financial institutions provide temporary funding options specifically designed for businesses facing cash flow issues. These loans can provide the additional capital you need to overcome these challenges. For instance, NBFCs offer competitive rates and repayment schedules that cater to your business. It allows for manageable repayments.