Working Capital for Business
One of the greatest needs that small businesses have is the need for working capital. Working capital is the lifeblood of the business, the fuel that funds the daily operations and ability to pursue near-term growth opportunities for the business. Working capital is officially defined as “….”. The financial equation for determining working capital is as follows: (Account receivables + inventory + cash on hand) – (Account payables + prepaids)
There are numerous sources of working capital for businesses. Looking at the equation, one way to obtain additional working capital is to increase account receivables (i.e., sell more) or convert the receivables to cash by getting customers to pay sooner. Continuing to examine the equation, another way is to increase inventory. When examining a company’s balance sheet for the purpose of acquiring that company, it is important to examine how these parameters fluctuate as part of the working capital. A company can increase inventory and receivables significantly, drastically increasing the amount of “working capital” denoted. However, those receivables could be essentially non-collectible and the inventory could be obsolete. Either of these would essentially nullify the advantages of a large “working capital”.
You can access cash by getting customers to prepay their orders by offering significant discounts for doing so. For example, if a customer buys a monthly service for $100, you can offer them a yearly pre-paid, discounted rate of $1,000. That’s roughly 20% off but when you factor in the time value of money, the discount drops by 5-8% (depending on your internal rate). If you sell much larger service contracts or products, the difference in actual cash can be profound with prepaids. From the other vantage point, you can get your supplier(s) to extend terms. So, instead of payment expected within 15-30days, you may be able to push it out to 90 days. You never know unless you ask.
From the perspective of the company owner, the larger the proportion of working capital in cash, the better. Cash can be spent on anything – to pay suppliers, pay employees, pay rent, pay for geographic expansion or product line development. Receivables and inventory not quickly converted to cash through turnover must be converted to necessary cash via financing that uses either or both of these two as the collateral for loans.
Working capital for business is something many small business owners do not plan. They often do not think about it until they encounter a cash crunch. Or sometimes, not until they have encountered a number of cash crunches and are tired of the stress of not knowing how they’ll make payroll or pay irate suppliers.
Last 5 posts by Deepak Shrivastava
- Life Insurance and It Benefits - October 11th, 2009
- Home Based Business Tips - October 7th, 2009
- Asset Finance Leasing - October 6th, 2009
- Important Thing For a B2B Site - October 4th, 2009
- Business Solution from Laughlin Associates - October 1st, 2009