How startups manage their working capital

Liquidity: 6 tips for improving corporate liquidity - Working capital management in practice

Lack of liquidity is a common cause of bankruptcy and it can happen to profitable companies as well. To reduce the risk, you should actively manage your working capital. There is a lot that you can do yourself here. Below are 6 small - but effective - tips for improving working capital.

1. Good receivables management improves liquidity

Successful companies often have very good procedures and processes for invoicing and receivables monitoring. It might seem obvious, but when you generate revenue, you are billed immediately. Don't wait until the end of the month.

In this way you create the basis for effective and good processes for monitoring and controlling the claims. Make it routine to send reminders early. The longer you wait, the more likely you will not be able to collect the overdue payment.

2. Shorter payment terms to customers improve working capital

To ensure that your company has good liquidity, the first thing to do is to check how much capital is being tied up in accounts receivable.

A good measure to stabilize the cash flow into your business is to check what payment terms you are giving your customers. It is still customary to set the payment term at 30 days - however, revising the payment terms can be worth its weight in gold.

Shortening the payment terms of your customers by 5 days frees up an average of around 1.37% of your annual turnover in cash. With a fictitious turnover of 2 million euros p.a., a payment term shortened by five days means that your cash balance is increased by around 27,000 euros. If you managed to shorten the payment terms by ten days, the effect would double accordingly. The release of more than 50,000 euros in free liquidity for a company with a turnover of 2 million euros would have noticeable effects. Remember, long payment terms is nothing more than a free, interest-free loan from you to your customers.

Be aware that the largest companies have a strong focus on capital commitment and use their great bargaining power to negotiate contracts and agreements accordingly. Many small companies therefore indirectly contribute to the financing of their largest and most important customers with long payment terms.

3. Good relationships with suppliers can bring financial benefits

Proactively negotiate the best possible agreements with your suppliers. Favorable purchasing conditions such as competitive prices and flexible or extended payment terms create entrepreneurial freedom. How good your individually negotiated terms are often depends on the reputation of your company, the consistency and duration of the business relationship and your status or how important you are as a customer.

4. Better payment terms from suppliers ensure better liquidity

To improve liquidity, you should try to extend your vendor payment terms as much as possible. If you are able to postpone the payment for your goods purchases by five days, this leads to an increase in the cash balance of 1.37% of the purchase value, analogous to the debit payment terms. Assuming that you can shop for 1 million euros and postpone your payment terms by 5 days, this will increase your cash balance by almost 14,000 euros.

Don't forget that the supplier side is also about negotiating power. Whoever holds the best cards wins. If you are a large and dominant customer, you can dictate payment terms to a greater extent.

5. Control of the warehouse increases liquidity

The way the warehouse is managed varies from company to company. A company that sells fresh produce, such as groceries, needs frequent shipments of goods and has relatively little inventory at all times. However, a company that has longer-term inventory will most likely receive less frequent but larger shipments. Companies that have this last form, in particular, often tie up (too) much capital in their warehouse.

Let's look at this by extending the example above. We continue to assume a cost of goods of 1 million euros p.a., supplemented by the assumption that the average value of the warehouse is 250,000 euros. Thus the turnover rate is 4.0. This means that over the course of the year the average storage time for the purchased goods is three months. This would correspond to one delivery every six months, each of around 500,000 euros. If instead it switched to deliveries every three months of 250,000 euros each, the average warehouse value would be reduced to 125,000 euros, which freed up 125,000 euros in liquidity. Conversely, this means that the average storage time for the goods drops to 1.5 months.

The ideal situation through just-in-time purchase of goods to avoid a warehouse, as is often seen, for example, with OEMs in the automotive industry. In practice, this is unfortunately hardly practicable for suppliers or subcontractors, because stocks are an absolute necessity for many industries in order to avoid production interruptions and to serve short-term orders.

It is therefore important for you as a company to use individually tailored and practice-oriented processes and systems to monitor the warehouse. Successful inventory management minimizes the amount of capital tied up without negatively affecting the company's delivery capacity.

6. Liquidity forecasts give you an overview

A rolling liquidity forecast and corresponding forecasts are effective management tools. They say something about what the cash balance will look like in future periods. Another benefit of a liquidity forecast is that it can help you raise finance for periods of less liquidity available. Furthermore, with a good liquidity forecast, you will be able to plan more precise measures with regard to your working capital.

Conclusion: optimization of working capital

In the above examples, a company with a turnover of 2 million euros and 1 million euros in goods costs Improve liquidity by more than 200,000 euros can, if it is possible to shorten the payment terms to customers by ten days, increase the payment terms to the suppliers by ten days and reduce the average storage time from three months to one and a half months. This could be critical to the future growth and profitability of the company.

Good liquidity management is not just about avoiding extreme situations like insolvency and bankruptcy. Good processes, procedures and procedures can free up capital and reduce the need for expensive external financing.

If you manage working capital actively and well, you will be more successful. The consequences are higher profitability and greater freedom of action. Overall, active working capital management will make your company better equipped to cope with fluctuations in the economy.