Five ways to keep working capital healthy for manufacturing firms

EVERY good business owner knows that working capital is necessary to keep operations running. It is what allows the business to meet its financial obligations, like paying its employees, creditors and suppliers. Companies with insufficient working capital are very likely to have issues with liquidity down the line despite having healthy profits.

Manufacturing companies especially require a sharp eye for monitoring and making sure working capital is healthy. Supplier and production expenses usually come months before the goods produced are sold to consumers. Manufacturers have working-capital management plans designed to anticipate and solve these issues. According to the PWC Working Capital Survey, since 2016 manufacturing has fared significantly better than other industries in terms of working capital performance.

Here are five ways to keep your working capital healthy, especially when many small businesses are only beginning to reopen:

– Process improvement. Being able to improve the manufacturing process is not only beneficial to your operations and working capital, but also to your consumers and brand. Developing high-quality products to consumers would also help build trust and loyalty among them. There are multiple schools of thought in improving the manufacturing process, but many of these have the same goal: optimize production through waste identification and reduction. Two of the more commonly known philosophies are “Six Sigma” and “Lean.”

Lean manufacturing or lean production, based on Toyota Motor Corp.’s production system, is a methodology that focuses on reducing waste and unnecessary cost while maximizing productivity.

When lean management is in place and working properly, fewer financial resources are required in manufacturing goods. Lean identifies several areas of waste to consider and improve on.

Six Sigma, on the other hand, reduces waste and identifies defects like anything that isn’t up to customer expectations. It was introduced in the 1980s by a Motorola engineer who believed that reducing variation would improve customer satisfaction and savings. Six Sigma makes use of the DMAIC (define, measure, analyze, improve and control) process, a data-driven improvement cycle that consists of several steps.

These are just some ways of identifying and improving the production process. However, reducing costs might not be enough to maintain positive cash flow.

– Manage inventory. In line with the lean- process improvement, good inventory management can also positively impact a healthy working capital for manufacturers. Production plans and orders must be scrutinized. Usually, businesses have several steps in managing their inventory better. To help keep their working capital healthy, manufacturers must ensure that demand forecasting is as accurate as it could be. Being able to know how much and when to produce and is key to keeping working capital healthy because this ensures that goods are sold as soon as possible and not just idle. Businesses want to avoid understocking, as well as overstocking.

To mitigate this, many manufacturers apply a just-in-time (JIT) inventory management system, also prescribed by the Toyota production system. It creates efficiencies by reducing inventory space needed and the risk of damaged stock. Having too much stock means cost for physical storage, as well as increased insurance. The JIT system is synonymous with Motorola’s shortcycle manufacturing and IBM’s continuous-flow manufacturing. This system, however, come with its own risks. Untoward incidents that hamper the supply chain will definitely affect companies that follow the JIT system more. These however, can be mitigated by contingency planning, or mitigated quicker if the company has an electronic resource planning system.

– Receivables collection. The ability to collect receivables faster is also very important in keeping working capital health because the cash flows are significantly improved. It ensures that money keeps coming in and payments are made on time.

Automating tracking and monitoring of accounts receivable would let the business know inflows much better. A good forecasting model of cash receipts would be very beneficial to mitigating uncertainty in the business, allowing working capital usage to be planned much more efficiently.

Prompt invoicing can help quicken the processing of receivables, as well as payment reminders. Some businesses would choose to offer discounts for early payments or fines for late ones. Sometimes, flexibility, in the form of direct debiting for big clients and prepayment options, is key to keeping the capital healthy in terms of receivable collections. However, if this is an issue, short- term financing like those offered by First Circle can help fill the gap between payments.

– Payables. Accounts payable can become a huge drain to the working capital source for manufacturing companies. Suppliers expect to be paid on time and this can significant reduce the amount of the working capital available.

Paying vendors on time also allows the company to reduce days payable outstanding. Generally, timely repayments are beneficial to both parties. Although, it may seem counter-intuitive to maintain the working capital of the company, paying vendors on time allows relationships to grow and build for the future.

Some companies choose to leverage this good standing relationship by negotiating with their suppliers and vendors for better payment terms and timelines. This may come in different forms, such as having payments over a longer duration, paying later, buying in volume or having discounted prices for paying up front. Keeping suppliers happy is a move for the long run, allowing better leverage in getting larger discounts for bulk purchases and recurring orders.

– Debt obligations. The cost of capital is increasing, and companies must ensure that they are using financial products wisely and sustainably. Paying off loans on time when they mature is imperative to keeping working capital healthy. Delayed payments can build up significantly and come with debilitating penalties.

There are many types of financial products out there. At a time when social distancing is a nonnegotiable factor for choosing to do business, as well as speed and convenience, online loans for financial technology (fintech) companies are at the top of business owners’ lists.

First Circle is among the top fintech companies that provide short-term working capital financing through our products: purchase order and invoice financing. We are able to provide loans in as fast as three to five business days without requiring face-to-face interaction; the submission of business documents will suffice. Even better, we only collect purchase order or invoice documents in place of collateral.

There are plenty of other choices, depending on your top considerations, of course. Choosing the best one with the most reasonable payment and interest terms is very important. Understanding each type of working capital loan is important, as it may make or break the health of the company.

These are just some ways to preserve and improve the health of a company’s working capital. A healthy working capital allows the business to ensure that day-to-day expenses can be covered after shortterm liabilities have been settled.