This is an original article written by Alex Newman, Co-Founder and CEO of Finance Fuel.
A quick definition so that we’re on the same page: Working capital is your cash for day-to-day expenses. More specifically, working capital represents short-term assets available to a business for meeting their financial obligations like payroll, creditors, and suppliers. Cash flow is your ability to generate cash over time, while working capital is a snapshot of what’s on hand.
Cash Flow Shortfalls Hindering Growth?
A company with insufficient working capital can have cash even when they have plenty of assets and sales are doing great. Manufacturing companies are subject to working capital challenges because supplier and production expenses usually require payment several months before goods are sold to customers. And then as you grow your business, you will need to find the cash to hire more staff, get bigger facilities, new machines and upkeep, and keep your marketing budget high. If you grow rapidly by landing a huge deal, which isn’t always easy to plan for, you’ll risk not having enough working capital to buy the materials to fulfill the new order.
Not having enough cash in the time between landing a big new deal (or 10) and realizing the profits is a common problem for manufacturing companies experiencing rapid expansion. It can damage your business reputation if you’re unable to fulfill the orders, and you need to make sure you’re prepared for that eventuality. Thankfully, there are a number of strategies for dealing with short-term cash shortfalls.
Managing Working Capital as a Manufacturer
According to a recent survey, the only challenge greater than working capital on the list of concerns for manufacturers is rising costs. The thing is, rising costs directly affect working capital because of how it impacts your margin and profits. Working capital management by manufacturers and other businesses is designed to anticipate and resolve such difficulties before they cause regular bill payments to be delayed, and well before the manufacturing process needs to be slowed down while you wait for outstanding invoices to be paid. If you’re the one managing finances in manufacturing you have a few strategies to improve cash flow. Running lean (lean manufacturing principles), invoice funding, and a bank line of credit are chief among them.
Lean Principles: Lean Manufacturing
You don’t need your Six Sigma Black Belt to understand how Lean principles can positively impact your business. Tools like value stream mapping can get you in touch with your current manufacturing process (and waste), and let you design what you’d like the future state to look like. Getting everyone on the same page about where you are, and where you’re going is a great way to improve your cash flow by reducing expenses.
Lean principles have been so effective in manufacturing that Lean has made its way into other industries. A lean business has the ongoing goal of reducing waste and unnecessary costs throughout the manufacturing process. It doesn’t need to be taken on all at once. Working towards your ideal future state can be made a little bit at a time, getting better every day. Fewer financial resources are required as lean management goals are achieved, and this translates to improved cash flow. However, reducing costs is a long road and doesn’t always help enough when you hit a big growth spurt or when costs suddenly increase.
Manufacturing has a challenge where it takes a long time to get paid. When a customer makes a purchase, you are financing their order. You buy the materials upfront for them, you carry the cost through the manufacturing process, and even after shipping and invoicing they have net terms with you so they don’t have to pay for 30, 60, or even 90 days. This results in a large gap between expenses and realizing revenue. It also results in large accounts receivable on the balance sheet.
In comes invoice funding. Invoice funding is a financial strategy that allows manufacturers to receive working capital based on their accounts receivable before payment has been made by customers. The pain you see growing on your accounts receivable balance sheet is seen, rightfully, as an asset to an invoice funding company. They take the payment history and reliability of your customers into account and will fund either all of your outstanding invoices or just the invoices you choose. Partnering with an invoice funding company can be beneficial for manufacturing businesses to consider when a customer’s invoice is on longer net terms, but the manufacturer could use the cash to fund further growth. Costs for invoice funding can vary widely, and finding the right partner that offers transparent terms is key.
Bank Lines of Credit
Manufacturing companies that are established have the benefit of being able to form long-lasting working relationships with a bank. Seeking working capital in the form of a line of credit from traditional commercial lenders such as banks is a great way to fund your operations and growth. Smaller, less established manufacturers will generally have different borrowing choices than large manufacturing companies. Another challenge is that banks haven’t changed much in the past 50 to 100 years. Their financial due diligence processes are time-consuming. It’s beneficial to a manufacturing company to find a banker that you trust and that’s a straight shooter. They’re not legally allowed to tell you “don’t apply, you won’t get approved and should look for other options”, but if you can read between the lines and your banker is a straight shooter they will set you on the right path.
This article originally appeared on Finance Fuel's blog.
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