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Working capital is key

July 27, 2014

While one of our interns was doing some file compilation, he brought to my attention that I had a high influx of clients in May compared with other months.

He asked me, “What is the reason?” 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 because of 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.

Few new businesses are profitable as soon as they open their doors. It takes time to reach your break-even point and start making a profit. Therefore, it is of utmost importance to be prepared from the start by 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.

Last but not least, as the Small Business Association 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.”

The sustainability of a business should be measured 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 using 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 break even, 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.