Managing working capital best practices

An idea is to negotiate with a bank to have a long-term line revolving line of credit. That way when you need to advance a few dollars from the line of credit, cash will increase by the amount borrowed, thus increasing your working capital. The increase to the line of credit of credit will not adversely impact your working capital because the LOC is long-term. Always remember to renew the line of credit before it reaches less than 12 months until its maturity date. Companies doing this need a good, solid banking partner to accomplish this.

Another idea, if you have officer payables that seem to increase, rather than decreasing, turn it into a long-term note payable. Interest expense will increase, providing you are required to compute and pay interest, but it could help with working capital needs.

It is a tough question to answer without knowing your particular circumstances. I recall a former client company where having the inventory on the shelf and customer-ready for overnight shipping was critical to their business reputation ("you need it -- we have it"). Stockouts were really bad news. So they were always in danger of carrying way too much inventory and one had to balance the "we have it" reputation against huge excess inventory amounts.

But at its simplest level, I have never found working capital management to be as critical as other cash needs, business measures and investments -- e.g. long-term capital needs, marketing programs, margins, expansion, shareholder dividends, etc. As long as you have some kind of working capital line to fall back on, it should not be hard to monitor or avoid wasting too much WC money in today's rate environment. AP usually rises and falls along with AR/inventory fluctuations, so you get some compensating credit there, and inventory always seems to be the WC item that needs the most watching. Of course, a couple of painful bad AR balances can be the real killer -- more than the "cost of carrying AR" -- or buying bad inventory. I would monitory those situations carefully.

I usually implement all the usual WC measurement criteria (AR aging, days sales in AR, days COGS in AP, inventory turns, etc.) and report them monthly with agreed limit warning bells. But I don't sweat over fluctuations by month or even quarter -- I only look for upward/downward trends that are not correcting themselves in a reasonable time. Mid- and long-term cash flow forecasts are more important to me than overmanaging the WC area. We often hear that driving WC down is an important financial management concept, but if you spend too much time measuring and micro-managing that, one can lose sight of bigger business issues and the longer term view.

PS -- good point Chris on keeping the LOC long-term. I do that at a current client -- always renews 18 months or 2 years out.