Your largest current assets, against which you might borrow, are probably receivables and inventory. Ideally, both of these assets turn into cash as soon as you wish. However, unless you manage them carefully, they tend to become a problem. To manage your working capital properly, you must know:
1. The age of your receivables and inventory, 2. The turn of your receivables and inventory, and 3. The concentration of your receivables (how many customers comprise the majority of your receivables, what amount of receivables they represent, what products the receivables cover) and inventory by product lines.
Five Steps to Managing Receivables
1. Age your receivables.
2. Calculate your collection period and apply the "40-day/30-day" rule of thumb to see if you have a problem.
3. Identify slow-paying customers.
4. Pursue delinquent accounts vigorously.
5. Identify fast-pay accounts and try to increase their number.
You must also know what your credit and collection policies are doing to your working capital. All too often small-business owners mistake sales for profits. They extend more and more credit, pursue lax collection policies, and end up financing their customers to increase sales. Most businesses cannot afford to provide interest-free loans to customers just because they expect it. Slow-paying customers must be subjected to profitability analysis, which takes in their carrying costs. If sales increases don't translate into profits on the bottom line, then you are buying trouble faster than you are increasing profits by carrying customers who habitually stretch their payments.
This material was adapted from Chapter 5 of Financial Troubleshooting by David H. Bangs Jr. and Michael Pellecchia. Copyright 1999 Goldhirsh Group Inc.