Capital gains

I've often heard business leaders discuss the term 'reducing working capital" but what does it really mean in practical terms to a business? Will working capital make or break a business or is it a term intended to blind us with a totally ambiguous meaning?

Working capital is exactly that capital. Cash tied up in suppliers, customers, stocks and assets - cash is king I suppose! In other words working capital represents the assets of the business tied up in the business. If you are using capital to run a business it is desirable to use as little capital as possible.

In theory any free cash could be sitting in a bank account earning interest. If it’s not in a bank then you’re losing out on interest and consequently a loss of capital for the company.

In difficult times, companies stop ordering, reduce stocks throughout their supply chain and put production to a halt in order to free up cash. However with current interest rates at historically low levels is a bank account the best place for any free capital?

In addition freeing up cash can also carry great risks. For example you risk losing the ability to deliver your customers on time in full and could also damage relationships by underperforming on customer service. Hence, working capital reduction requires a multitude of different actions, in order to be effective or it could potentially be extremely harmful and leave a business in bad shape when the economy begins to show signs of sustained growth.

Some companies I’ve spoken to over the last year have taken the strategic decision to reduce working capital and re-invest in their maintenance strategy. The argument being that by investing in effective processes, conditions, controls, and engineers, the efficiency of the plant will be significantly enhanced, preventing shutdowns and erratic and expensive downtime. The result is by re-investing the cash saved by reducing working capital through careful consideration, will actually result in further cash savings by greater efficiencies. The alternative would have been to leave the money in a bank accruing interest at rates which would not give any where near as significant a saving as those made by re-investing. But the key is looking at your business structure and procedures with eyes fully open.

Reducing working capital is not just a bankers term in my opinion, it has real meaning and has the potential to save industry money if implemented correctly, but it’s not just about saving money, it’s about what you do with the savings once your business is lean. Re-investing in maintenance is just one possibility and is largely dependent on your business - so think laterally and keep your eyes open at all times!