Allowing for working capital is not only essential when purchasing or setting up a business for the first time, it’s essential on an ongoing basis for survival and growth. Previously, I have discussed the importance of knowing what your breakeven point is in your small business. Following on from this, is having a good handle on what your working capital requirements are for your business. Typically after time, many small business owners draw down their trading account balances on a monthly or even weekly basis, and then wonder where all the money has gone when they get to the end of the following month. Working capital requirements can change over time in your business, due to increasing or decreasing sales, inventory, debtor accounts, creditor terms, or all of these. To work out your working capital requirement, its: WC = inventory cost + (plus) accounts receivable by you – (less) accounts payable by you, as a percentage of sales each month. How relevant this is, can vary from business to business - i.e. retail and manufacturing businesses have larger stock levels and trade debtor needs than most service businesses, etc.
So why is it important to understand your working capital requirements in small business today? Not having enough working capital may signal that the business’s margins/profits are declining, or too much money is being taken out by the owners themselves, who think that increases in cash flow reserves are actually profits ripe for the picking. Excess working capital on the other hand, means money could be re-deployed into other business ventures or investment opportunities, which can increase return on investment. The wash up is, poorly managed working capital means that positive strategic opportunities, new marketing initiatives, product development and alternate business models may be overlooked, or not even considered due to shortfalls in cash within a business. The small business bumbling along, always doing what they have always done, simply because that’s the way it’s always been, becomes the easy beats to those that are constantly scanning the environment for new opportunities and taking them. Why? Because those that have that depth in working capital are able to act and able to make changes required to remain competitive. This does not always mean re-inventing the wheel, it could be as simple as being able to take advantage of bulk buy discounts or new product releases from suppliers before some of their competitors do, finding new suppliers, or taking on complementary products or services.
Increasingly, what is evident is that those that maintain a healthy working capital holding, or ‘growth capital’, as part of their business strategy are better positioned for what the future may throw at them, than those that haven’t. Likewise, as a pointer for buyers of existing businesses, some consistent interest earning in the financials over several years can help re-assure them that the business is healthy enough to be ‘capable’ of maintaining a working capital holding.
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