Recession or not, we have resources to help your business master this moment of high interest rates, labor shortages, sticky inflation, and slower growth. We've put together our Agility & Excellence Resource Center to bring you strategies and solutions with a finger on the pulse of what's ahead.

Despite continued appetite for growth, achieving it can be a challenge for today’s business leaders, who must now contend with high interest rates, declining GDP growth and general economic uncertainty.

To free up the cash needed to take a business to the next level, firms should focus on a concept they may have overlooked when sales were up and growth rampant: working capital optimization. The difference between a business’ assets and its liabilities and debts, working capital is a measure of liquidity—and a crucial assessment tool for lenders.

Managing your working capital takes on added importance when things slow down and interest rates rise, driving up the cost of credit. One example: a PE-owned waste services company we recently worked with couldn’t expand its borrowing capacity to execute planned growth strategies because of decreasing cash flow—even though its monthly earnings before interest, taxes, depreciation and amortization remained strong.

Though sales were good, the company had too much cash tied up in receivables, on top of a high debt load and other issues. To achieve the PE owners’ desired growth, the company needed to improve its working capital ratio by speeding up collections and reining in spending.

Fortunately, there are proven ways to improve how you manage working capital. To get your company back on the path to growth, focus on accounts payable, accounts receivable and inventory.

Consider These Four Questions for Working Capital Optimization

1. Do you have a credit policy?

Generating trust and building relationships with customers is important. But if reduced cash flow is hindering working capital performance, now is the time to establish (and enforce) a credit policy.

For instance, do your customers have to fill out a credit application? Does someone at your organization run a credit check? Do you require a credit card on file? Do you have clear credit terms (i.e., do customers have to pay in 30, 60 or 90 days?)?

2. Are you collecting slower than you're paying out?

Review steps in your order-to-cash process, from the moment a customer order comes in to when a payment is received and applied to accounts receivable. Look out for problems that slow the process down–-miscoded invoices, for example, or failure to comply with pre-authorization requirements before billing customers for certain services.

To optimize working capital in the current economic climate, you should be collecting faster than you are paying out. From the customer side, you might explore whether you can offer incentives to have them pay early (e.g., if you pay within the first 10 days, we can give you a 2% discount).

On the accounts payable side, this may require better vendor management. For instance, if your customers take 60 days to pay you, you should have transparent conversations with vendors about extending your payment terms. Most vendors will appreciate these conversations; if they don’t, you might look at others and potentially even play one vendor’s terms off another.

3. Are you doing effective cash forecasting?

Making the purchases necessary to fuel growth and expansion can’t happen without accurate cash forecasting. Forecasting creates a critical bridge between planned and actual business performance, allowing management teams to optimize their return on attention and resources, avoiding surprises along the way.

An easy way to start is to go back to your bank statements and work backward from there, on a weekly basis. Where did the balance begin and end that week? What receipts came in? What went out? Once you’ve done that for previous months, you can use that data to forecast for the months to come— factoring in seasonal expectations, desired purchases and other anticipated fluctuations.

With robust 13-week cash forecasting, you’ll have a clearer picture of expected cash flows, reducing reliance on expensive short-term financing options during cash shortages by allowing management time to make decisions proactively to avoid such shortages.

4. Do you have an inventory management strategy?

Inventory is considered a current asset when managing working capital. Companies need to have enough inventory on hand to meet customer demand. But having too much inventory increases storage costs and the risk that products held for too long may spoil or expire, which in turn contributes to higher net working capital.

Organizations that loaded up on inventory during the pandemic as a hedge against supply chain disruptions may need to adjust their approach, perhaps by shedding excess inventory, exploring options to decrease hold time or renegotiating supplier agreements.

Adopting the last in, first out (LIFO) method for inventory valuation in an inflationary and high interest rate environment could offer a considerable advantage. If your company purchases inventory at a higher price than previously paid, using the LIFO method means that the most recent and expensive inventory is the first to be expensed, leading to a higher cost of goods sold. This increased cost of goods sold can reduce taxable income, resulting in significant tax savings. Business leaders should consider whether LIFO makes sense by evaluating whether the method aligns with long-term objectives and must ensure that the book conformity requirement for LIFO is tenable.

People, Processes and Technology are Key

Through our work with the above-mentioned waste services company, the organization saw a 15% decrease in days sales outstanding by speeding up collections. A robust cash forecasting tool and management shifts led to several other benefits, including a restructured credit facility that allowed for expansion.

Each step of the way – from invoicing to forecasting – it was important that people got on board with clear, effective processes. Only then could the tools and technologies we offered reach their full potential.

For growth-oriented companies, accounting and finance functions may not have been a primary focus as the economy boomed. In today’s slow-growth economy, however, executives can’t afford to overlook this opportunity to leverage additional working capital to drive up the value of their business—and expand it while others contract.

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