In this series of articles, you will learn how to effectively manage your working capital cycle, WITHOUT having to borrow from external sources of funds. It is a secret which not many small businesses know about. The reality is that borrowing external funds is the most expensive way of managing working capital. There are other ways of getting around this situation, without having to dip into an overdraft or utilize invoice discounting by selling your invoices to fund your working capital.
As a small business owner, it is your responsibility to ensure that you manage your working capital as best as possible, because, as a growing business, you will continue to experience great difficulties managing cash flow even though you may be profitable. If you resort to business loans, finance from banks and NBFCs, or working capital financing, then there is always the burden of owing someone else which will be in the air. That is not to say that you should be utilizing your own funds, but a cheaper source of funds where there is a lower burden of repayment. Remember that there are loads of additional forms of working capital financing which you should be looking at, and they mainly come from your stakeholders.
Please note that your stakeholders are very important to your business, and whilst these tips are good for working capital management, they should not come at the expense of ruining relationships with good stakeholders. Always be prepared to discuss matters with them and you will be surprised at how open they are.
We have already discussed how to manage your working capital cycle with your customers – in this article we will discuss managing the cycle with your vendors.
Stakeholder – Your Suppliers
Your suppliers are an important part of the holy trinity which makes up your stakeholders in the working capital cycle. They too perform a very important role, providing you with the necessary raw materials, stock or other products and services which are important to running your business. Should they stop providing them to you, well, there is a high chance of your business seizing to operate at all. Unfortunately, at the same time, suppliers consist of a cash drain for your business, and your need to analyse how best to manage them to help you better streamline the working capital demands that will be placed upon you. It is interesting that whilst reducing the time taken for stock and clients (ie – invoices) to be turned into cash, improves your cash cycle, increasing the time taken to pay your suppliers does the same. But take heed; playing this game with your suppliers is a risky one, especially if they are large and you are small. Here, we can show you a few ways of managing the risks around this:
- Develop relationships with key vendors –
Your business lives and dies by these guys, so make sure that you give them lots and lots of attention. Wedding invites, coffee chats, anything which will make sure that these vendors warm to you, and know you on a personal level. If you know about their spouses and families, it creates a level of trust with them which you will benefit from. If the suppliers are large corporates, the same applies. Try to develop a good working relationship with anyone working within the organization who could influence the way your business operates.
Please note that your stakeholders are very important to your business, and whilst these tips are good for working capital management, they should not come at the expense of ruining relationships with good stakeholders.
- Understand order cycles for your product –
if you can start predicting when your products/services are about to sell versus a low period, then you can give ample notice to your suppliers, allowing them to plan in advance as well, which will almost certainly lead to lower pricing, as well as better payment terms. But how on earth do you get this crystal ball to predict what your order cycles may be? Well, one way of reducing this risk is by creating contracts, so that you know what your orders will be during the year. Another way is by looking at historical sales and frequency and regularity of purchases by existing clients.
- Develop lean practice –
you need to actively monitor your procurement cycles to ensure that you are not taking on too much inventory which will take longer to sell than it will for you to pay your suppliers. If this is happening, consider having those honest discussions with your suppliers in order to match deliveries with payment cycles.
- Review procurement contracts –
a very simple way of increasing the days to pay your suppliers is a review of the procurement contracts. It could be a case that your procurement contracts were set up many years ago, and simply have not evolved as your business has grown. The fact that you have had good relationships with your suppliers should set you in good stead to renegotiate the terms on which you procure inventory, thereby giving you a better grasp on your working capital.
- Always have back up suppliers and keep them happy –
make sure you spread your risks and not have too much reliance on any one supplier; this is vital to ensure that you won’t be completely at a loss should that supplier’s prices jump or if they cannot make the delivery which you so require. But also, ensure you keep procuring from your main and back up suppliers as well, because this will keep them happy, and also, more importantly, keep them on their toes knowing that there are other procuring partners that you can call upon.
The fact that you have had good relationships with your suppliers should set you in good stead to renegotiate the terms on which you procure inventory, thereby giving you a better grasp on your working capital.
These are some simple ways of helping you extend the time taken to pay off your suppliers. Remember the 80:20 rule – 80% of your time should be spent on your top 20% suppliers, who you procure most from. Start with them and then gradually work your way down to the smaller suppliers, to put the most energy in the biggest wins. Also, no matter what you do, always be in contact with your suppliers, and always pay them relatively on time. This will start giving your small business an element of trust in the market, which is invaluable later, when you start approaching new suppliers and start asking for credit terms on procurement.