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Your Bank > Education and Advice > CNB University

Are You Managing Your Working Capital?

Next to cash on deposit at your financial institution, working capital is the most important asset in your business. Working capital is defined as the current assets minus current liabilities. Current assets consist primarily of cash, accounts receivables and inventory while current liabilities consist primarily of accounts payable, short term borrowings and accrued expenses. The difference of these two items provides the working capital measure of how much in liquid assets a company has available to support and build its business. The number can be positive or negative, depending on how much debt in the form of current liabilities, the company is carrying. In general, companies that have a lot of positive working capital will be more successful since they can take advantage of prompt payment discounts and lower overall borrowing costs. Conversely, companies with negative working capital may lack the funds necessary for growth.

Management of current assets is important to maintaining a good working capital condition. Cash is already available with accounts receivable and inventory converting to cash over time. Accounts receivable can be managed through good weekly or bi-weekly internal reports. While payment terms vary from 10 days to 60 days or more, adopting a procedure to contact customers prior to the invoice due date may improve collection. The purpose of the contact is to ascertain if the invoice has been received with the goods and to determine that all is satisfactory with the order. It is also good to confirm the payment terms. Certainly this maybe overkill for a long term customer, but it can be used with new customers or customers that make their payments late. While making contact does not assure prompt payment, it does start the clock for the follow up call, if payment is not received shortly after the due date. Contacting a customer after the invoice is late, slows the collection process and if there are any issues with the shipment, payment maybe further delayed.

Good management of inventory is also important because dollars tied up in excess inventory are not available to pay accounts payable. Inventory management consists of maintaining an inventory system that tracks the age of items in stock and their relative turnover rates. Good inventory management practices save money by reducing the investment in the inventory items plus handling and storage costs.

Speeding up the conversion cycles of inventory to A/R's and A/R's to cash can produce savings through reduced borrowing costs, ability to take discounts and less exposure to inventory obsolescence and A/R collection risk. A company with positive working capital will generally use their line of credit sparingly to support seasonal growth or to take advantage of prompt payment discounts. Borrowing to pay for supplier discounts can improve a company's profitability. Companies with negative working capital usually borrow more and cannot take advantage of supplier discounts; both of which increases their cost of doing business.

If you have questions about managing your company's working capital, please contact a CNB Commercial Lending Officer for suggestions on your company's specific requirements.

Bob Lowenthal is a Senior Vice President in the CNB Commercial Services Group
You can reach Bob at (585) 394-4260 x36108 or via e-mail.