HOW TO REDUCE WORKING CAPITAL REQUIREMENTS 1: Manage your accounts payable
Working Capital funds the cost of the labor & materials that go into the goods you sell or the services you render (i.e., your Cost of Goods Sold or Cost of Sales) and what you use to pay for salaries, rent, office supplies, etc (i.e., your operating expenses). In most businesses (specially where goods are produced), the greater portion of Working Capital goes into Cost of Goods Sold.
One of the most effective ways of reducing the need for Working Capital is through suppliers’ credit or your accounts payable. It would be a great advantage if you were able to establish relationships with your suppliers where you can delay payments (say, 30 or even 60 days) with only a minimal increase in price or, better still, without any additional cost. In this kind of arrangement, you can actually pay for your supplies from the proceeds of your sales or collections –thus, lessening the pressure on your Working Capital requirements.
image from Microsoft Clipart
Is giving a post dated check to your supplier advisable?
Thanks for dropping by, Arnulfo.
It’s a common practice. Whether you issue a post-dated check or not, make sure you will be able to cover the accounts payable on due date. If you’re asking for post-dated checks from your account receivable, select the most reliable payor and match it with the post-dated check (i.e., the check will clear a day or two before the due date of your own post-dated check).
Every time I see the suggestion of stretching payables as a way of improving cash flow I want to scream. It usually ends up costing businesses in the long run. First, it immediately weakens vendor relations. Does anyone really think the vendor doesn’t mind waiting for its money? What about its cash flow?
Even more damaging is the fact that many times the delay will result in a duplicate payment. How is this possible you ask? When an invoice is not paid for 30 days most suppliers will issue a second invoice. Now, in theory, if everything were perfect in the business world, these second invoices would not get paid. But, in reality, a small number do. But even if only 1% get paid a second time, the results are not good – and all the gains from the payment stretching program have been given back – and then some.
So, while on the face of it, payment stretching would seem to increase cash flow, it often does just the opposite.
Well, enough of my ranting.
Mary Schaeffer
author Controller & CFO’s Guide to Accounts Payable (John Wiley & Sons 2007) and 12 other business books
editorial director Accounts Payable Now & Tomorrow (www.ap-now.com)
Thanks for dropping by and the warning on what can happen if your accounts receivable days are longer than your accounts payable days (http://www.accounting solver.com/synergy-between-accounts-receivable-accounts-payable-2/).
Another working capital hog is inventories. so if you follow good inventory norms along with defining reorder, economic order quantities your should be able to reduce your working capital requirement.
Regards,
CA Ashish Ahuja, FCA
A Roaming Blogger and a CA
Indian Chartered Accountant New Delhi India
Indian Company Formation Delhi India
Appreciate your dropping by.
If you do your economic order quantities with “just-in-time-ordering” you can have greater reductions in your working capital for inventories.
You have to know the turnaround times for materials delivery & velocity of sales.