HOW TO REDUCE WORKING CAPITAL REQUIREMENTS 3: Manage your accounts receivable

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.

What you want to do with your Cost of Goods is to turn it into cash as fast as you can (i.e., sales). One way of stimulating sales is to extend credit to your customers (i.e., set up an accounts receivable for valued / preferred customers). However, this puts pressure on your Working Capital –specially if your Cost of Goods Sold is more than 30% of your Revenues.

To mitigate the effect of postponing the receipt of cash from your sales to customers to whom you have extended credit, you have to make sure that the period in which you have to pay for accounts payable is longer than the collection period of your accounts receivable. This is doubly important if you have funded your Cost of Goods from suppliers’ credit.

A well-managed accounts receivable leads to less Working Capital needed.

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