Why management of working capital is a must.
July 13, 2017
He asked me the reason why. After trying to think of different reasons, my conclusion was that around midyear people have thought about starting a business long enough and maybe have received some extra money from their tax return to start the new journey.
But the million dollar question becomes, “How much money do I need to start my business?” Of course, due to the nature of your business, your industry, the amount of initial capital investment will vary. You might feel you have thought of every single initial cost your business will require, but more often than not I see entrepreneurs forgetting about “working capital.” That is the money we need to pay salaries and the bills due at the end of those first months. Very few new businesses are profitable as soon as they open their doors. It takes time to reach your breakeven point and start making a profit. Therefore, it is of upmost importance to be prepared from the start securing enough money to cover three to six months of working capital.
As mentioned before, not all businesses are the same. Some companies are inherently in a better position than others. Many retailers have little to worry about when it comes to accounts receivable because customers pay for goods on the spot. Inventories represent the biggest problem for retailers, therefore, they must perform inventory projections or they risk being out of business in a short time.
In other industries, timing of payments can pose serious troubles. Manufacturing/service companies, for example, incur substantial upfront costs for materials and labor before receiving payment. Much of the time they consume more cash than they generate in that particular period.
And last but not least, as the SBA mentions “Businesses that are seasonal often require more working capital to stay afloat during the off season… For example, a company may do significantly more business over the holidays resulting in large payoffs at the end of the year. However, the company must have enough working capital to buy inventory and cover payroll during the off season as well, when revenues are lower.”
One measure of a sustainable business is when it is able to pay off its day to day expenses from its daily revenue. Many businesses make the mistake of forgetting about their daily expense coverage and they end up utilizing personal resources, borrowing money at high interest or closing their businesses. Without knowing how much money you need to run your business on a daily basis and how long it may take to reach breakeven, you can quickly find yourself in a cash flow crisis.
In conclusion, the adequate management of working capital is a must. Forecasting working capital correctly will help you know whether your current assets are enough to cover your current liabilities or expenses.
“Business Tips” was written by Adriana B. Havins, Senior Certified Business Advisor, of Angelo State University’s Small Business Development Center. For more information on the topic of this article or the services of the ASU · SBDC, contact her at Adriana.Balcorta@angelo.edu.