Strong Working Capital Helps Weather Economic Stress

Key Takeaways:
  • Working capital is crucial for manufacturers to maintain operations, especially during economic uncertainty and high-growth periods.
  • Proactive strategies like precise cash flow forecasting, tight inventory control and optimized AR/AP practices can significantly improve a company’s working capital position.
  • Strong working capital not only helps weather economic challenges but also empowers better strategic decision-making and sustainable growth for manufacturers.

 

For high-growth companies, periods of economic volatility can exacerbate liquidity problems. Cash that is needed for operations to meet growing customer demand may be in short supply, or may come at a higher cost due to interest rate fluctuations.

What is the Working Capital Cycle of a Manufacturing Firm?

Working capital is the term used for cash that is needed for short-term liabilities. For growing manufacturers, managing working capital through times of economic stress is critical to keeping your company operating and making sure orders are filled.

Working capital – also called net working capital – is the difference between a company’s current assets and current liabilities. It measures the company’s liquidity and short-term financial health, indicating the ability to fund operations and respond to financial stress or opportunities.

Banks look at a company’s level of working capital when a business applies for short-term financing. It is becoming particularly important as certain manufacturers are preparing for the impact of new tariffs.

Working Capital in High-Growth Companies

Companies in a high-growth mode often see a shortage of cash because they’re using cash at a higher rate than other companies to keep production and order fulfillment at high levels. They’re spending more on raw materials or components, utilities to power production machinery more hours of the day, and they are likely incurring overtime costs for their employees.

If economic instability is added to the mix, high-growth manufacturers can find it challenging to maintain enough working capital to fund operations.

But there are strategies for optimizing your working capital to ensure that your company can remain on a strong growth trajectory.

How to Improve Working Capital in Manufacturing

The following strategies can help optimize working capital:

  • Forecast your cash needs on the operations side, as well as any capital expenditures you may need to make. Update your forecasts at least monthly, and run different scenarios. The economy can change quickly, and scenarios can help determine how your company will perform if the economy takes a dip, or it suddenly speeds up, or if interest rates rise. Your forecasts will help with planning and making decisions about spending, as well as decisions about when to draw on a line of credit or other financing. Forecasting may shine light on the need to delay nonessential spending. Perhaps a capital project can be put off for six months or a year. On the other hand, if delaying a capital project – such as a building expansion or machinery purchase – ends up slowing down production, accessing financing to make the purchase may be the better way to go to help accelerate the company’s growth.
  • Manage your inventory closely. Being in a high-growth mode can lead to overproduction, so inventory must be controlled. A lot of money is tied up in inventory, including the costs of workers’ wages, of running machinery and buying raw materials and components. Spending all that money only to have a warehouse full of unsold goods can be financially disastrous. This may be the time to move to just-in-time production, which will enable you to meet customer demands without overproduction. Your financial forecasts should help you determine the inventory levels you’ll need in the immediate future.
  • Tighten up your accounts receivable and accounts payable (AR/AP) practices. Anytime you’re in an expansion or growth phase, your receivables grow disproportionately as you gain new customers. Make sure you have the proper credit policies in place for new customers, and consider offering early payment discounts as an incentive to get cash in the door more quickly. Install automated invoicing and payment reminders to make sure completed orders are invoiced in a timely manner. Put in place a good collection process, staffed by a capable team. On the accounts payable side, learn how you can work with vendors to slow down your payments to them. Negotiate terms with vendors, and consider buying in larger quantities if you can get volume discounts.
  • Technology and automation go a long way toward making your operations as efficient as possible. Make sure you have the machinery and technology you need on the manufacturing floor and throughout the company to make sure data is accurate and operating processes are efficient.
  • Research the types of financing that are available to your company. Even if you don’t need it right now, if you need it in the near future the need may arise quickly. Does it make sense to buy new equipment, or lease it? Is a line of credit better than an actual loan? What terms would you want, and how will current interest rates affect you?
Questions?

Having adequate working capital helps improve cash flow and allows you to continue your company’s growth trajectory. Most importantly, a healthy working capital position allows you to make more meaningful management decisions and look further into the future as you engage in strategic planning.

In short, a healthy level of working capital allows you to weather the storms of the economy and any unusual marketplace stresses.

If you would like to discuss how your company can take steps to optimize its working capital, contact an Adams Brown manufacturing accountant.