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We can hear our customers now! How can working capital (isn’t that cash flow?) be bad for the financial health of my business? Let’s talk about it.
The technical financial folks define this as a very basic calculation that even a non-financial business owner can do: simply deduct your current liabilities from your current assets (from your statement) and voila! Congratulations, you have working capital. Let’s hope that number is a positive number, because when it’s negative you’re technically insolvent and that’s a topic and solution for another day!
Anyway, our number is positive, that’s good, right? Not necessarily, and that’s the premise of our data that we’re sharing here, because if you have positive working capital, your funds are tied up in accounts receivable, inventory, and prepaid items.
Therefore, it is very important to understand what constitutes working capital, how you can monetize it or generate cash flow, and most importantly, but often completely overlooked, how you can measure business capital.
The essence of measuring your working capital revolves around billing, days sold pending, inventory turnover, and days pending payment.
The good news is that you can very easily calculate and track these measures, and we can virtually guarantee that they will help you better understand why your investment in working capital is largely a reeling of good news and bad news.
You like to travel? Money does too, and consider how long it takes for a dollar to travel through your company. From the day you place an order, buy a product, pay for a product, invoice an account receivable, and yes, collect that account receivable, that total cycle can easily be 200 days, if you write down more. That’s a lot of traveling, so I hope you can see our premise here that your investment in your working capital accounts isn’t necessarily a big deal.
Your business consists primarily of inventory, accounts receivable, and accounts payable (also fixed assets). Therefore, we strongly encourage clients to understand the turnover and overall performance they get from these key asset accounts.
I’d understand your situation a little better if it weren’t for those pesky problems you can’t control—business owners and financial managers are well aware of them and run into them every day. They are growth and decline in sales, fixed costs that you have to pay and manage no matter what, and any financial difficulties you may be experiencing due to prior external factors, ie a bad year, etc.
The holy grail of business capital and working capital financing is when you have tight controls on internal asset turnover while at the same time having access to external working capital through bank lines, asset-based lending facilities, loans, grants, etc.
We constantly remind clients that whether they are delivering their working capital accounts more efficiently all the time is indeed a measure of the true success of their business: think about it, are you buying things, paying for supplies on time, and paying for supplies on time? Customers are paying you on time and ordering more goods and services. A quick tool to gauge your progress in this area is to simply take your days of accounts receivable and days of inventory, subtract your days outstanding, and whether that number is improving or decreasing, you’re gaining ‘working capital’ is bad for your health’ premise that we have presented.
As a Canadian business owner, you grant and apply for credit (customers and vendors respectfully). Understanding business capital in this way will allow you to better finance internally and borrow through banks, finance firms, asset-based lenders, etc.
Talk to a trusted, credible and experienced business financial advisor about our ‘health’ problem and what your tools and solutions could be for better business success.