Working capital is the lifeblood of any business. It’s used to pay rent, payroll, vendor bills and to purchase the tools and materials to produce goods and services.
For a startup or growing small business, working capital is especially important. Having enough cash flow and managing it properly allows a business to develop its core offerings, maintain smooth operations, expand into new markets and hire top talent. In fact, there’s a good chance if a small business fails, it’s because it ran out of working capital.
Company founders have a lot on their plates as they try to get a business off the ground and move it through growth stages, and sometimes developing an effective working capital management strategy may not be a top priority.
Rob McCaslin and Logan Wyant, commercial bankers with Central Bank of the Midwest, think it should be. They recently shared their thoughts with the Kansas City Business Journal about how business leaders can develop an efficient working capital management strategy.
Strategy 1. Think beyond sales growth
Many small business owners spend much of their time focused on the sales side of their operations because they believe revenue growth is the most important way to measure success. But that can be a false indicator, Wyant said. A more important metric is profitability — because if you haul in a lot of money but can’t make a profit, you’re going to go out of business.
“If you sacrifice margin and profitability just to gain revenue, that can put you in a strained situation rather quickly,” Wyant said. “Profitability-focused business models that reduce costs and increase productivity and efficiencies often are the best way to build a solid business foundation that can ensure long-term success.”
Spending so much time on sales growth also might mean other areas of the business get neglected, which can lead to increased expenses and headaches to course correct, McCaslin said.
“There are many demands to growing a small business, including developing a solid management team, launching marketing initiatives and keeping an eye on what your competitors are doing,” McCaslin said. “Growing revenue is important, but it shouldn’t come at the expense of all the other areas of the business that need an owner’s attention.”
Strategy 2. Manage revenue cycles
Companies in early growth stages can also improve their working capital position by managing payment terms within their customer and vendor relationships. The desired outcome is to shorten the cash conversion cycle, leading to less reliance on debt and a more efficient use of the company’s cash.
“You want to hang on to as much cash as you can in the short term so you have money to purchase inventory and supplies ahead of schedule and keep the production process flowing,” McCaslin said. “As a small business grows and purchases more from its vendors, it gains leverage with them to adjust expectations about the timing of payments.”
One way to bring customer payments in more quickly is to automate the accounts receivable function to collect money more efficiently than a business would by receiving paper checks in the mail. Studies show accounts receivable automation has helped small- and medium-sized businesses process payments faster (87%), improve team efficiency (79%) and deliver superior customer experiences (75%).
Strategy 3. Identify financial blind spots
It’s common for owners of growing firms to develop an outside team of advisors that includes an attorney, accountant and banker. At early stages, when a business is trying to establish its financial footing, the banking relationship is the one that may be completely free.
Building a relationship with a banker gives the owner access to a trusted advisor and the relationship can grow as the business grows. A knowledgeable banker can customize financing solutions for the business as it enters different growth phases and also provide advice based on the best practices the financial professional has seen by working with companies of all sizes and in all industries.
Such advice can be invaluable when it comes to helping the small business owner identify financial blind spots. Examples of business areas to review include moving from manual to more efficient automated processes, employing digital tools to forecast future cash flow needs and creating efficiencies to better manage overhead expenses and balance sheet health and liquidity.
The banker can also help identify sources of working capital that go beyond accounts receivable, such as working capital loans, lines of credit and private equity.
Wyant advises due diligence to find the right banking partner because there’s no greater risk to small business success than choosing the wrong financial institution.
“Don’t underestimate the value a banking relationship can bring to a business moving through different growth phases,” Wyant said. “You want to find a long-term partnership — not one that’s there just for the first deal. Lean in on the relationship for the financial expertise and solutions that can boost the odds of sustained success.”
