Along our series of Business Tips that could drive your business in the safe waters of revenue and prosperity, we have already analyzed the Importance of Managing by Objectives, and is now the time to talk about the importance of working capital.
Defining Working Capital
In a company, Working Capital is everything that is either cash, or something that can quickly be turned into cash. So Working Capital includes money that people owe you for work you have completed, and also the inventory of materials that you could quickly finish and sell for cash.
Working Capital Sqeeze
Almost all companies are in a Working Capital squeeze. You generally have to pay Payroll, Payroll Taxes, Rent, and Supplies in cash this week. But even if you deliver something this week, you may not get paid for 30 or 60 days.
Ironically, if your company is successful, the Working Capital squeeze often becomes more intense. You are hiring more staff, and buying more supplies, but payments from customers never seem to catch up.
One problem is that unless you are a quite large company, banks will be reluctant to lend you money for Working Capital. Banks like to lend money for machines, vehicles, and buildings. If anything goes wrong the bank can take the vehicle, and sell it to get their money back. The temptation is to plan the money you need to open the doors, but forget that you need ongoing day-to-day money.
There are six things you can do:
- First, in your planning, try to include day-to-day cash for Working Capital. In a perfect world you see recommendations to have up to 3 months of sales as cash, but that is probably unrealistic for most of us. Small companies can often operate with 3 weeks cash.
- Second, unless your company has a lot of investment money, it may be best to use the bank to finance your machines, vehicles, and buildings. Leasing companies are also very eager to help in this area. Then you can preserve your investment cash for Working Capital.
- Third, taking Credit Cards and Paypal can speed up collections. Be professional but forthright with customers on payment terms. Sometimes a small discount for prompt payment works well. Because of our upbringing, collecting money is difficulty for all of us. However, you have to be determined to make those collection phone calls.
- Fourth, keep your inventories lean. For unusual components, it may be better to order only when needed and pay the extra overnight shipping fees, rather than have a lot of components sitting and gathering dust. Always think “How quickly can I convert this item into cash?”
- Fifth, use subcontractors for everything that is not central to your business. You only need to pay them when you use them, and they are often flexible on payment terms.
- Sixth, you can use “factors” if you really get into a cash crunch. A “factor” advances cash against the list of money customers owe you (Accounts Receivable). This is a little bit of a last resort as factors will take perhaps a 7% commission. Keep this one in reserve.
One big caution – do not be tempted to make tax deposits late. Failure to make timely tax deposits will soon cause complete failure.
We have considered Working Capital concerns in the context of small and medium sized companies. However, big companies can also fall into the Working Capital squeeze. Astonishingly, General Motors did not keep a very good cash forecast spreadsheet, and in November 2008 announced that in 1 month they would have no money to pay payroll.
So keep a simple cash forecast plan, and concentrate every day on completing work that can be quickly sold for cash.