Working capital management

Working capital management means operating efficiently by using working capital effectively. Working capital is typically defined as current assets minus current liabilities. More practically, it's often considered accounts receivable plus inventory minus accounts payable.

There are three main strategies for managing working capital: lowering it to maximize cash flow, aiming for higher working capital to maximize profitability, or outsourcing it altogether to focus on other strategic areas.

To maximize cash flow, companies aim to reduce their cash conversion cycle. This involves reducing Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and increasing Days Payables Outstanding (DPO). Examples include investing in IT for inventory tracking, standardizing credit terms, and negotiating longer payment terms with suppliers.

For companies with sufficient cash and operating in a low-interest environment, increasing working capital can boost profitability. This might involve offering longer credit terms to customers for higher selling prices, holding more inventory for better service levels and improved margins, and offering shorter payment terms to suppliers for discounts.

If management attention is focused elsewhere, working capital can be outsourced. Factoring involves selling accounts receivable to a financial institution at a discount for immediate cash. Financial institutions also offer inventory financing and supplier financing, which mirrors factoring but for accounts payable, allowing companies to delay payments or suppliers to get early payment.