Net working capital is a company's ability to pay its current debts with its current assets. On the balance sheet, it represents the difference between a firm's current assets (cash, accounts receivables and inventory) and current liabilities (accounts payable and accrued expenses). It's a critical measure of a company's financial health since it indicates the business' ability to pay off its debts within one year.

Businesses always need positive working capital and cash flow to grow their companies. They can still grow during a recession if they have access to more working capital and specifically have their assets in cash or cash equivalents. With working capital, they can seize an opportunity when most other companies may be struggling.

Here are some ways you to understand what is working capital management and how you can use it during a recession:

1. Aggressively monitor financial fundamentals.

Ensure that your company has an adequate working capital cash-flow cycle by reviewing your cash-flow statement monthly and projecting it into the future with the help of a pro forma profit and loss statement. This can give you the ability to make strategic decisions.

You can help maximize your cash position by monitoring accounts receivable collections to keep a low days sales days outstanding (DSO).

Look for additional suppliers that can source similar products. Having multiple suppliers can also set up a pricing competition between vendors to lower your supply chain costs.

Consider minimizing customer credit and postponing large expenses that don't immediately generate cash flow until after the recession. Ensure a positive working capital cash-flow cycle where money is coming into the business at a faster rate than it is going out.

It may also be beneficial to review your operating working capital which is defined long term assets versus all long term liabilities. The formula for calculating it is (assets - cash and securities) - (liabilities - non-interest liabilities). This tells the company if it has enough long term assets to meet it's long term liabilities. A company where this number is negative may need to adjust net profits and liabilities for a more positive future outcome.

2. Minimize inventory.

During a recession, companies that get stuck with large inventories that are not selling to customers risk not having enough cash because too much of it is invested here.

Carefully monitor the trend of how often inventory “turns" (that is, how many days or months the average product is in inventory before it's sold). Try to reduce a fulfillment rate (how often the product is in stock when a customer orders it) to a level that is still acceptable to the customer. Reduce the reorder points (at what point stock is ordered) and reorder quantities (how much is ordered at one time).

3. Hire cautiously.

During a downturn, many companies reduce expenses by laying off their employees. Not only do they lose skilled team members that may be needed later, but these actions can seriously hurt the company culture and morale.

Consider only hiring full-time employees where they are absolutely needed and will generate or secure current cash flows now. Consider using freelancers, part-time staff or outsourcing the function for additional flexibility.

4. Boost margins.

The current business needs to be protected by reducing costs and increasing efficiency. Higher margins can help produce more net profit and ultimately more cash flow.

While it is difficult to raise prices during a recession, try to reduce material and any supply chain costs from vendors. Many times, this can be achieved since these companies may be struggling with their sales and may be willing to sell at a lower price.

5. Analyze your product mix and pricing strategies.

During a recession, there is generally a shift toward demand of only essential goods and services. There is also a downward pressure on prices. To keep or boost sales levels, consider diversifying your revenue sources.

For example, while new product equipment sales may drop, maintenance of existing products may increase as customers keep their purchases longer. Focus your resources on expanding your maintenance programs among your current customers. On pricing, bundle products or other services together to create more value for the customer—during recessions, customers typically seek better financial deals.

6. Get multiple suppliers.

Many companies have a hard time running their business during a recession. They may not be able to provide the product you need when you order it.

Look for additional suppliers that can source similar products. Having multiple suppliers can also set up a pricing competition between vendors to lower your supply chain costs.

7. Draw on lines of credit now.

Borrowing money from outside funding sources becomes more difficult during a recession. If you have a line of credit, consider drawing funds from it now, even before it is required, and keep the money in a separate cash account. This way, it will be available when more working capital is needed; the small amount of interest you pay may be a worthwhile expense to ensure you have adequate cash flow. The companies that survive and thrive during recession are those that know what is working capital management and how to maximize the cash retained inside their company.

Read more articles on financing.

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