Efficient working capital management and optimal cash flow synchronization

How do companies choose their operating cycle? How do companies choose their cash conversion cycle? What is the impact of the company’s operating cycle on the size and frequency of investments in receivables and inventory? How do seasonal and cyclical trends affect the operating cycle, cash conversion cycle, and investments in current business assets? These strategic policy issues relate to the optimal timing of cash flows and the effective management of working capital aimed at maximizing the wealth generating capacity of the business.

In this review, we will review some relevant and existing academic literature on effective working capital management and provide operational guidance for small businesses. The shorter the cash conversion cycle, the smaller the size of the company’s investment in inventory and receivables and, therefore, the smaller the company’s financing needs. Although the establishment of ending cash balances is, to a large extent, discretionary, certain analytical rules can be applied to help effectively formulate better judgments and optimize cash flow management.

As you know, a correlation with cash flow is net working capital. Net working capital is not cash, but the difference between current assets (what a business currently owns) and current liabilities (what a business currently owes). Current assets and current liabilities are respectively the company’s immediate sources and uses of cash. Clearly, a company’s ability to meet its current financial obligations (invoices due within one year) depends on its ability to manage its current assets and liabilities effectively and efficiently.

Effective working capital management requires the formulation of an optimal working capital policy and the periodic management of cash flow, inventory, accounts receivable, accrued liabilities and accounts payable. And because poor working capital management can seriously damage a company’s solvency and limit its access to money and capital markets, every effort should be made to minimize the risk of business failure.

The importance of liquidity cannot be overstated. Furthermore, anything that negatively impacts a company’s financial flexibility degrades its ability to borrow and weather unforeseen financial difficulties. A business must preserve its ability to react to unforeseen expenses and investment opportunities. Financial flexibility arises from a company’s use of leverage as well as cash holdings.

In practice, optimal working capital management includes an efficient cash conversion cycle, an efficient operating cycle, determining the appropriate level of accrued liabilities, inventory and accounts payable, and associated financing options. Working capital policy impacts a company’s balance sheet, financial ratios (current and quick assets) and possibly credit rating. A good understanding of its cash conversion cycle, or the time it takes for a company to convert cash invested in operations into cash received, is essential to the effective management of a company’s working capital.

The cash conversion cycle captures the time elapsed between the start of the production process and the collection of cash from the sale of finished goods. Typically, a business buys raw materials and creates products. These products go into stock and are then sold on account. After products are often sold on credit, the business waits to receive payment, at which point the process begins again. Understanding the cash conversion cycle and the aging of accounts receivable is critical to successful working capital management.

As you know, the cash conversion cycle is divided into three parts: average payment term, average collection term, and average inventory age. The company’s operating cycle is the time between the receipt of raw materials and the collection of payment for products sold on credit. The operating cycle is therefore the sum of the inventory conversion period (the average time between when raw materials are received into inventory and the product is sold) and the receivables conversion period (the average time between a sale and cashing the receipt). Note that the operations of a merchandising business involve buying (purchasing goods), selling (selling products to customers, and collecting (receiving money from customers).

A few operational tips:

There is an accumulation of empirical evidence suggesting that effective working capital management begins with assessing the operating cycle and optimizing cash flow from business operations. Management must know, understand and anticipate the impact of cash flow on business operations and its ability to maximize the profit generating capacity of the business. Effective cash management is essential to the success of a business enterprise. It’s all about cash flow.

One of the best ways to increase the availability of cash is to accelerate the receipt of incoming payments by reducing the age of accounts receivable using an appropriate combination of incentives and penalties. A business should assess current payment processes and identify effective options to accelerate accounts receivable collection.

There is strong evidence to suggest that improving payment processes and moving to electronic alternatives will maximize liquidity and better manage receivables costs. Liquidity is essential to the success of any business venture and effective cash management is at the heart of liquidity. In practice, careful cash flow analysis and assessment of investment strategies and policies are necessary to ensure that a company has the appropriate tools needed to maximize business liquidity and optimize cash flow management. Treasury.

A company optimizes cash flow management in its operating cycle by streamlining, streamlining and improving the way it manages cash inflows, makes outflows and minimizes the aging of accounts receivable. A business needs digital records, electronic banking, robust internal controls and agile accounting systems for fast reconciliation of bank statements through quick access to bank accounts, customer records; and synchronize cash flow, accounts payable and accounting systems for increased efficiency.

Industry best practices include monthly cash flow analysis to determine the ending cash balance (the difference between total cash inflows and total cash outflows). The objective is a periodic increasing or positive closing cash balance; Monitor customer balances to manage accounts receivable (money owed to the company by customers); and proper pre-qualification processes before extending credit to customers are key to minimizing the incidence of bad debts.

A tracking system that monitors outstanding debts and sends automatic reminders, invoices and statements is a useful tool. Some companies use factors by selling their receivables to factoring companies to ensure stable cash flow; Slow cash outflows: Prudent cash flow management requires a business to hold on to cash for as long as possible. Optimize cash flow management by paying on time while using all amenities compatible with the financial benefit calculation. Finally, borrow long term and lend short and long term for major expenses, setting aside small amounts to fund major planned expenses. Always remember that long-term liabilities become current liabilities in the accounting period in which they mature.

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