Working capital. You have probably heard them coming out of high end corporation’s executives, bankers or accountants. Like most finance terminology, it means something very simple, but so many SME owners do not really know what it is and how important it is to them and their business. So, we are going to be breaking out what it is, and what does it mean to you as an SME owner.
Working capital, the definition:
By doing a 5-minute search on google you can find Investopedia’s definition “A calculation of current assets vs current liabilities”. Bear with me, I know this is just a text book definition. What we want to know is what does it really mean!? … Well, Working Capital is nothing more than the capital used to run your company on a day to day. This has many arguments as accountants will start saying, what about CAPEX and X, Y Z. Again stick to simple, if you need the money to run your business, then it is a working capital requirement.
Let’s take ABC Marketing agency as an example, they just took a lease for a new office in order to grow their business and to have all the staff in one place. The lease payments will be considered a working capital requirement.
In my perspective SMEs are one of the biggest working capital users in the world. The reason? simple. Most of us as SMEs are growing. Growth is a process that requires working capital, I.E it requires you to invest money on the day to day operations of your company. Using the same example as before you could say:
ABC Marketing has been trading for about 2 years and are making $20,000 of sales every month, best part is that they are still growing. To manage the growth and being able to cope with the demand, they hired Sally and Dave. Sally and Dave are both on a $50,000 package. This means that to sustain the growth of ABC, the owners just invested $100,000 in working capital (capital used to run your business, your staff is a big part of running your business).
It is very critical to understand our working capital requirements. Even though we as SME owners are big working capital users, some tend not to track it or manage it appropriately hence having to borrow money to fill the gap. As mentioned before, borrowing money without understanding why are you borrowing money is probably one of the biggest mistakes one can make.
You might be thinking, well Working Capital sounds exactly like cashflow, the truth is that it should. The main difference is:
- Working capital measures the ability for a business to continue its operations throughout the year, whereas cashflow focuses on the cash available that the company has.
So now that you know what working capital is and how to track it, how can you manage it better?
In addition to our 7 Steps to improve your business post, you can do the following:
Collections:
- Offer discounts to customers in order for them to pay earlier.
- Work on processes to improve collection times.
- Systematize your collection process in order to save time and resources.
Payables:
- Push payable terms (pay later).
- Negotiate with suppliers in order to facilitate cashflow.
- Do not hire a lot of people just because you project growth, hire them as you grow.
- Manage payroll efficiently.
It all comes down to managing your assets and liabilities (nothing new) but by tracking it and understanding your working capital it will make your business life a lot easier.