Ways to unlock cash and improve your net working capital

Manage cash flow

Learn why it’s important and how it can drive overall business value.

In many businesses, working capital—the cash used to maintain your inventory, order goods and services, and offer your customers competitive payment terms—is often overlooked and undervalued for its potential to improve a business’s worth.

Earnings and the cash flows they produce naturally take center stage. They fund growth, pay down debt, and add value to the business. But as a business grows, a portion of that cash flow goes to working capital to support day-to-day operations. When that happens, that money becomes bound to the business and is no longer available to pay for business growth initiatives—or to sink to the bottom line.

Tighter management of accounts payable, accounts receivable, and inventory can release cash that can be used to pay off debt, support strategic investments, or return capital to owners. Releasing working capital further improves capital productivity, generating earnings with less money at work. Investors, potential acquirers, and owners can all appreciate a higher return on capital.

Understanding the working capital cycle

A company’s working capital cycle is the amount of time it takes to convert its inventories into cash. The length of the cycle varies by industry and helps determine a company’s financial competency. Shorter cycles produce cash more quickly to maintain operations, recover investments, and meet certain business objectives. Longer cycles require more cash to maintain operations.

Improving your working capital management offers an intriguing opportunity. There’s little financial risk involved, and increasing its efficiency can be additive to other strategic business initiatives.

Why should I work on optimizing my working capital?

Improving your working capital management offers an intriguing opportunity. There’s little financial risk involved, and increasing its efficiency can be additive to other strategic business initiatives. 

Many businesses consider unlocking working capital “low-hanging fruit,” but it can be easy to overlook. Smaller businesses are often absorbed with growth and don't have time to focus on capital improvement. Meanwhile, bigger businesses miss the opportunity because they’re focused on debt and capital structure. Typically, it’s middle market companies that excel at freeing up working capital.

Benchmark working capital: What’s my opportunity?

The best way to see potential is to quickly restate your company’s financials. How would they have improved with better working capital management? See how your cash flow would change, raise business value, and release capital back to the owner.

Key performance indicators (KPIs) quantify financial activities so you can evaluate their success. Zero in on KPIs that hold the key to tightening your working capital so you can put it to better use. Look to metrics such as days sales outstanding (DSO) for accounts receivable, days payable outstanding (DPO), and days inventory outstanding (DIO) against peer companies in the same industry.

A working capital KPI can be either a simple figure or an equation, like your cash conversion cycle. The lower you can get the number, the less capital you tie up maintaining inventory and operations while awaiting payment.

Want to see how companies in various industries manage working capital? You can find benchmarks using:

  • Truist Financial Insights – Your relationship manager and Truist team use industry standards to help you better understand your opportunities for improvement and set working capital benchmark targets.
  • Middle market research – Use the National Center for the Middle Market’s online Working Capital Benchmarking Tool to help you establish goals for your business.
  • Industry trade groups, professional associations, and government agencies – These organizations often generate key benchmarking statistics or point to relevant sources of data.
  • Business data – Find detailed industry information online and through subscription services.
  • Professionals who know your business – Turn to trusted business advisors and industry consultants for information on local and industry metrics.

External benchmarks are important, so make sure you compare your own KPIs to industry standards and similar companies. If others are performing better, look for ways to improve and set your goals accordingly. Working through the financials and looking for opportunities to boost business valuation can help you focus on working capital reduction.

The mechanics of reducing working capital

The principles of releasing funds for more productive use are simple. Working capital is the sum of your cash, accounts receivable, and inventory, less your current liabilities, mostly in accounts payable. To lower working capital needs and free up cash:

  • Reduce the amount of credit you offer your customers in the form of accounts receivable.
  • Lower the funds tied up in inventory at every stage of production.
  • Use the full terms offered by your vendors to increase your accounts payable.

As you map out a plan, there are a few things to consider.

Accounts payable – Companies often overlook the opportunities in accounts payable. Can you negotiate better payment terms or early payment discounts? Pay electronically for precisely timed payments or by card to extend your payables. Make sure you’re using the full range of payment methods with your vendors, such as Automated Clearing House (ACH) payments, which can offer low-cost electronic payments. Purchasing cards allow you to pay vendors electronically and quickly while you get extended terms to pay your card. Create your payment policy by setting terms by payment method. You might pay vendors within 10 days of invoice with a purchasing card, within 45 days via ACH payment, or 60 days with a check. Your improvement in managing payables will come from financial processes that include the discipline to adhere to them.

Accounts receivable – The best way to reduce receivables is to secure payment at the time of delivery or service to reduce your days sales outstanding (DSO). Make it easy for customers to pay you by using merchant services or ACH transactions to get paid before you even set up a receivable for your customer. At a minimum, start the collections cycle with fast invoicing for speedier payment. Set collections policies and adhere to them using every automated follow-up and personalized tool at your disposal. Turning paper to electronic methods lowers costs for you and your customer while speeding collection. As a bonus, eliminating paper checks means removing a major source of fraud.

Inventory – Instead of building large inventories, consider a “just-in-time” system where items are obtained only when needed. Look closely at your days inventory outstanding (DIO) for ways to reduce it and encourage staff to keep inventory moving. Enterprise resource planning (ERP) systems and inventory management systems help keep inventory levels in check, reduce carrying costs, and pinpoint obsolete items.

Create a cash culture to preserve your gains.

Companies manage their working capital best when employees across the organization embrace the cash-to-value link, identify bottlenecks, and improve their KPIs.

Imagine a salesperson who’s negotiating payment terms, thinking about the best way to get cash in the door faster. Then, it’s not just the finance department worrying about sticking to the receivables policy but also employees who understand the importance of cash to build company value.

Take these actions to create a cash culture and increase your capital efficiency:

  • Talk about working capital.
  • Establish goals and accountability.
  • Make working capital management a top priority.
  • Empower your staff to take actions that preserve working capital.
  • Reward your employees when KPIs hit your targets.

If you want a staff that thinks like an owner, education on the value of speedy collections or extending payables is a great place to start. And it’s an excellent step toward sustaining value-creating gains.

Looking to lighten your working capital burden and free more cash?

Get fresh ideas from your Truist relationship manager or treasury specialist on how to improve your working capital management.