Optimise liquidity with working capital management
According to a study by the DIHK, 40% of German companies state that they are struggling with liquidity bottlenecks in the current Corona crisis. In order to survive the crisis (as well as possible), securing their own cash liquidity is currently the top priority for many companies. For this purpose, expenditures (cash outflow) are reduced to a necessary minimum on the one hand, while inflows of funds (collection of outstanding debts, increase in sales) are maximized on the other hand.
Another way to improve liquidity in the company is to release capital tied up in the company. The search for potential to release tied-up capital forces companies to put the topic of Working Capital Management back at the top of the agenda.
Importance and goals of Working Capital Management
What is working capital?
The term Working Capital is initially a key balance sheet figure that provides information about a company's liquidity. In German, it is best translated as net current assets. Simply put, Working Capital represents the amount of capital that the company is entitled to, but which it (usually) does not have immediate access to.
Examples of working capital include high inventory levels or invoices not yet paid by customers.
A low (but still positive) Working Capital therefore means that the company has little capital tied up and manages its liquidity successfully.
A company's working capital can be determined as follows:
In addition to the direct economic impact on companies, the current coronavirus crisis is also accelerating the developments already initiated by digitalization. Business processes, both within the company and throughout the market, among customers and competitors, are constantly accelerating and changing. This increasing dynamism makes it more and more difficult to make investments with a long-term time horizon (e.g. in long-term projects, real estate investments, expensive machinery or equipment), as the long-term benefits and return are much harder to predict. As a result, these investments are no longer justified. The uncertainty for the company increases.
In order to survive crisis situations and to be able to react quickly and efficiently in an increasingly competitive market and competitive environment, it is essential to have sufficient liquid funds. Working capital management is a tool for increasing liquidity and improving the company's profitability. The focus here is on optimizing all financial flows - both within the company and between the company and its business partners.
An essential aspect of WCM is the so-called Cash Conversion Cycle (CCC). The CCC describes the processes starting with the investment in the production of products, through the storage or further processing of the products, the sale up to the inflow of liquid funds through the sale. From this analysis, findings can be gained on the cash conversion cycle, i.e. the duration of capital commitment in the company, and potential for optimization can be derived. Because the shorter the cash conversion cycle, the sooner the company has liquid funds at its disposal.
Measures to reduce working capital in the company
1. reduce the duration of storage
Reduce the duration of your stockholding. The aim should be to hold as little stock as possible. Optimization potential lies above all in reducing throughput times, for example in relation to incoming and outgoing goods or transport routes, as well as minimizing safety stocks.
2. reduce amounts of outstanding payments (receivables)
- Optimize receivables management: Check how many of your customers' invoices have not yet been paid and push for these items to be settled.
- Shorten payment terms: Shorten the payment terms in your invoicing. Ensure that specific payment terms are stated in the future (number of days until payment is due after receipt of the invoice).
- Sell receivables (factoring): Sell outstanding receivables (e.g. invoices that the customer has yet to pay) to a factoring provider. This provider settles the outstanding debt immediately, usually at a discount, so that the company can immediately flush money into its own coffers.
- Adjust payment terms: Offer your customers additional payment methods where possible, e.g. down payments, advance payments or alternative, digital payment options. In this way, parts of the receivables flow back into the company earlier.
3. postpone payment of supplier invoices (liabilities)
- Extend payment terms: Agree longer payment terms with your suppliers. In concrete terms, this means that you postpone paying your supplier's invoice for as long as possible. In some industries, it is accepted that you only pay your suppliers when the corresponding turnover has been generated with the purchased goods.
- Bonus & Malus Agreements: In the case of long-term supplier relationships, try to negotiate bonuses in advance (“discount”). Based on the expected annual turnover, the supplier makes an advance payment and grants a discount, which is repaid if a certain turnover threshold is not reached.
A reduction in working capital can also be achieved by avoiding investments and fixed costs. This protects cash flow and increases financial flexibility. Various approaches can be used for this, such as:
4. outsourcing of non-business-critical tasks
Outsource projects and activities that are not necessarily related to your company's core business to external partners. This gives you the opportunity to ramp up or ramp down capacities very quickly if required.
Service provider contracts can also be cleverly restructured, e.g. through revenue sharing or by setting up a cost-plus model.
5. replace CapEx with OpEx
Capital expenditure (CapEx) refers to investments where the entire sum for the purchase of a product is paid in advance. Depending on the investment (e.g. real estate, office equipment), this can be very expensive. Operating expenses (OpEx) refer to expenses that are necessary for the ongoing operation of a company. As a rule, these are paid monthly or annually (e.g. in the form of rent or leasing).
Even if CapEx can make sense in some cases, OpEx is more advantageous for many reasons:
- Lower investment costs: In the OPEX model, you save your capital and increase liquidity at the same time. Use the freed-up capital to further develop your company and your business model instead of tying it up elsewhere.
- Flexibility: Companies that rely on OPEX models benefit from greater flexibility for the company and can adjust as required. Long-term planning is becoming increasingly difficult in a dynamic world. OPEX - unlike CAPEX - can be ramped up or down at any time.
- Tax advantages: Expenses incurred as operating expenses (OPEX) can be claimed 100% for tax purposes.
Example office equipment
A classic example of how high investment costs can be avoided is in the area of office equipment. Purchasing office equipment usually involves high acquisition costs. Renting office furniture or technology is a flexible alternative that many companies are already taking advantage of. Instead of high one-off payments, only low monthly rental payments are made, which reduces the burden on cash flow. The following calculation example illustrates this.
A company wants to procure new workstations for its 50 employees, consisting of a desk, an ergonomic office chair and a high-performance laptop .
Purchase of office equipment:
- The company pays around EUR 3,700 per workstation when purchasing office equipment.
- This means that an initial EUR 185,000 has to be paid.
Rent of office equipment:
- Alternatively, the company can also rent the products and spread the costs over the rental period.
- Only 105 euros per month is payable per employee.
Effective working capital management has numerous financial and operational advantages. In particular, increasing global competition, and not least the special challenges in times of crisis, make a company's financial capacity to act absolutely necessary. Optimizing working capital represents a favorable and sustainable form of corporate financing and, moreover, secures liquidity.
As a professional office equipment rental company, Lendis helps you to flexibly furnish your office with furniture and electronics without putting too much strain on your cash flow. We are always available to advise you. We are also happy to support you in planning your office.
Protect your working capital by renting office and IT equipment. Secure your liquidity for what really drives your company forward thanks to fixed monthly installments.