Working to increase cash reserves makes sense in a lot of scenarios. Doing so is a way to hedge against economic uncertainty or in preparation for a major growth spurt. But many organizations fail to see the danger inherent to pursuing the “cash is king” mantra to the ends of the earth.
Hyper-focusing on working capital often leads to tunnel vision. In pursuit of liquidity, organizations don’t recognize the longer-term damage they may be doing to their operations and strategic partnerships with key suppliers.
Lack of Growth & Innovation
“You have to spend money to make money.” Having an excessively large cash reserve means you aren’t using that money to invest into research and development, looking for new products and services to build, or growing your business.
Simply put, cash on-hand that isn’t doing anything is inefficient. Any working capital strategy should be tied to specific goals – have a purpose for that cash, because working capital strategies are only a means to an end, not an end in and of themselves.
Organizational Stagnation
The problem goes beyond simply missing these opportunities. A push to collect cash while forsaking growth could lead to a long-term mindset shift in organizational leaders. Decision-makers may avoid riskier moves that go against “king cash,” despite the fact that higher cash reserves help support daring operational pivots that could benefit the company.
This is a penny wise, pound foolish mentality, and dangerous for any organization that lives or dies based on innovation. There will always be a hungry, up-and-coming competitor who outmaneuvers a bigger player that isn’t taking risks or looking for the next step the market will take.
Damaged Supplier Relationships
A common working capital strategy is to shorten payment terms with customers while delaying payments to suppliers. The difference creates a positive cash flow that looks good in a company’s books.
This is strategy with clear winners (the organizations delaying payment) and clear losers (customers rushed to pay earlier and suppliers who may not see payment for 60 days, 90 days, or even longer). What’s worse? The suppliers with the least negotiation leverage, smaller firms with less working capital of their own, are the ones often forced into payment terms that could cripple them. Many small businesses can only cover three to six months’ of operating expenses in the best of conditions. Net-90 payment terms could seriously complicate, or even bankrupt, small businesses in a bad economy.
Moving Forward
How do we solve working tunnel vision? We stay true to the original vision that our working capital programs were meant to support. Don’t pursue liquidity without having a use case for that liquidity. Don’t put supplier relationships in jeopardy for short-term sprucing of a balance sheet.
Understand where your organization is headed, and build a working capital strategy that will help get you there.
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