A Strategic Approach to Working CapitalBy Jorge de Lara | Thu, 02/04/2021 - 09:26
2020 will go down in history as one of the most challenging years for business owners. According to information from the Study on Enterprise Demographics 2020 (EDN), carried out by the National Institute of Statistics and Geography (INEGI), no less than 1 million SMBs in Mexico closed their doors due to the pandemic.
Measures adopted to face the health crisis forced a great number of companies to shut down or radically modify their operation. Vendors, providers and customers had to also adjust their behaviors, processes and expenses, deeply testing the resilience of the whole economic and social ecosystem.
Small businesses face a particularly challenging scenario as reduced sales brought about by frozen operations, increased customer churn or commodity chain difficulties, directly affected cash flow, straining operational liquidity. Entities have begun to face real risks to their working capital, potentially compromising their very survival.
Working capital is of structural importance for any organization. Having the resources to manage short-term debt and foreseeable operational expenses is the basis upon which enterprises ensure their viability and build their growth. The appropriate use of financing options can guarantee the needed cash flow to navigate payment and collection periods or procure necessary materials or machinery without decapitalizing the company.
When we speak of financing options, we refer to a broad array of solutions that offer different benefits to each entity, depending on their situation.
Traditional bank loans might be the better-known option but they are certainly not the only one available and they do not always respond to current needs. When it comes to working capital, a bank loan can help fund the acquisition of equipment or facilitate the completion of an office space renovation. But when it comes to day-to-day expenses, there are other financing options that better adapt to differing costs, payment periods or a constant need for flexibility.
A Strategic Approach to Working Capital
Having a clear understanding of what a company needs can help teams fully reap the benefits each financing option offers. Such strategic implementation requires decision-makers to have concrete knowledge of their working capital (current assets minus current liabilities) while considering the impact of different variables:
- Nature of the business: How does the company usually operate? How deeply were its operations affected by the pandemic? The path to recovery will look very different for a service business than for a manufacturing entity. Which processes should be prioritized to ensure operational continuity? Mapping out the underlying structure that keeps your company together will ensure you spend and invest in the right place.
- Sale and purchase cost fluctuation: How stable or volatile are the costs of supplies, machinery, transport or other necessities? If such expenses see significant shifts from one period to another, working capital requirements will inevitably reflect those. This becomes particularly critical during unpredictable market stretches like the one we are going through right now.
- Supply chain: Is the organization’s supply chain adequately structured and organized? Taking a closer look to detect possible inefficiencies or evaluating how to simplify the chain – working with local vendors, for instance – can really build toward a more stable operation that can then leverage financial options in a healthy manner.
Once these factors are taken into account, a more detailed picture of working capital can be outlined. It’s important to remember that good decisions are taken not only by getting to know the details of different solutions but by having a clear understanding of what you need.
A strategic approach to working capital means finding the safe combination of financing options that don’t put the company’s assets at risk. An organization’s CFO or administrator can make informed decisions based on recurring and fluctuating expenses in order to find the solutions that directly address such requirements.
Focusing on the effective administration of working capital is not new but the many challenges 2020 introduced have really strained cash flow and forced financial teams to look at each expense under the microscope. An efficient working capital strategy is not about cutting expenses indiscriminately or halting purchases altogether. Being efficient is about reducing wasted resources while building resilience. Remember, we are speaking of lean operations, not emaciated ones. The appropriate use of financing options offers increased maneuverability, enabling the nimbleness current challenges demand.