Your business can't have enough cash. But since you probably don't have money trees growing behind your office, plant or wherever you hang your shingle, you have to depend on working capital.
An easy-to-remember adage for working capital is, “If you don't have working capital, you won't work."
An in-depth explanation requires more math and antacid.
If you're looking to brush up your skills or strategies on how to increase your working capital, you may want to consider these ideas.
1. Calculate your liquidity cushion.
“Since working capital is an accounting concept, it's probably easier for companies to think in terms of how much liquidity cushion they should maintain," says Mike Luebbers, chief credit officer for Lighter Capital, a Seattle-based lender that specializes in funding tech startups.
“The basic premise is that companies should have access to enough cash to cover operating expenses during the time when they're waiting to collect on customer sales, plus the amount needed to cover vendor payments if they buy inventory for later sale," Luebbers says.
So how do you determine that?
“A company can start to estimate its cash need by looking at how long it takes between paying for their inventory and collecting on customer sales," he says. “If the company pays for its inventory 30 days after purchasing it, sells it 15 days later and then allows its business clients another 30 days to pay the sales invoice, then that company will have a 45-day working capital gap to fill."
Figuring out how many days you're looking at is the first part of the math. Now you need to work out the actual cash numbers.
“If the inventory cost $5,000 and the company has rent, payroll and other operating expenses totaling $10,000 per month, then the 45-day gap would equal $20,000," Luebbers says.
Does your business fall into this hypothetical? You still may come away deciding you need more money.
“If the company plans for continued sales growth or experiences somewhat unpredictable sales and collection timing," Luebbers says, “it would want to maintain a higher working capital cushion."
The key to everything is making [the] strategic decisions that will least impact your ability to continue to grow and to sell.
—Ben Smith, CEO, Xcellerate Biomedical Technologies
Typically companies will look to fill their working capital gap by relying on a mix of the business's funds and debt, with ongoing profits helping to defray the need for debt over time, he explains.
"To the extent company owners consider debt, it's worthwhile that they understand how small-business lenders typically look at working capital financing," Luebbers says. "In its simplest terms, small-business lenders will look at the company balance sheet to see the level of accounts receivables and inventory, and then lend a fraction of those assets.
"The ratios will vary by company and industry, but are typically 70 to 80 percent of collectible accounts and receivables and usually no more than 50 percent of quick-moving inventory," he continues. "Ideally, small-business lenders will provide a line of credit that allows the company to borrow and pay down debt in line with their cash collections and operating expenses."
2. Recognize that once you figure out your working capital, it may change.
In fact, it probably will change because nothing stays the same. Especially if you're a business—you're continually growing or going through growing pains.
“While the ideal way to calculate the total amount [of working capital] will vary from industry to industry, there are three key things business owners need to keep in mind," says Nishank Khanna, chief marketing officer of Clarify Capital, a boutique lending firm in New York City.
● Your operating cycle. “The operating cycle is the average period of time a business needs to spend cash to produce goods, sell the goods and receive money from customers in exchange for the goods," Khanna says. “It's one of the most critical pieces in starting to project working capital needs."
● Seasonal trends. “If your business sector has seasonal trends, your working capital needs will vary during the year. Retail businesses are a prime example," Khanna says.
● Your short- and long-term business goals. “Successful business owners create a game plan for their growth," Khanna says. “Based on the resources needed to achieve that growth, add up all the associated costs. This could include capital needed to open a new location, hire more employees or buy new equipment."
3. Innovate to keep your working capital going.
Of course, sometimes you can forecast cash flow and calculate that working capital, plan ahead and plot.
But all of that mental activity may not change your situation when you need working capital now and you don't have enough.
That's when you may need to rely on your creativity.
Ben Smith is the CEO of Xcellerate Biomedical Technologies, a Phoenix-based company that makes BioXcellerator, skincare products sold to medical professionals. Smith has been the CEO and operating officer for multiple startups, a period when working capital is often an issue.
“Having more [working capital] is always better and makes life easier," Smith says. “But for those times when you need to stretch yourself, obviously credit cards are a way to go—lines of credits based on existing contracts are [also] very attractive."
At first, BioXcellerator didn't have enough working capital to make all of the products they wanted to offer, so they put out a limited amount of products so they could sell while raising more capital.
“The key to everything is making [the] strategic decisions that will least impact your ability to continue to grow and to sell," Smith says.
In the early days of organic and natural beauty company Maple Holistics, the business lacked working capital to run during a very busy holiday season.
“We actually had to raise prices to lower sales, so that our limited manpower could physically fill all of our orders within a reasonable amount of time," says Nate Masterson, Maple's chief marketing officer.
"The number one tip I'd offer to a business owner looking to determine working capital is to err on the side of caution," he adds. "Getting burned by ending up with a surplus is a far, far better predicament to have than running out of costs."
4. Spend some of that working capital.
You can never have too much cash, but you can make a good argument that there's such a thing as having too much working capital.
If your company is sitting on a mountain of cash or has a long, long, long line of credit, you're probably doing well. In some ways, you almost can't have too much working capital.
"A higher credit line won't backfire since they would only pay interest on capital utilized," Khanna says. "On the other hand, if an owner gets a term loan that is much larger than needed, they will be stuck paying interest on underutilized working capital."
And Luebbers points out that too much excess cash sitting around possibly "could be better spent investing in upgraded equipment, additional sales staff or perhaps an accounts receivable clerk to remind clients to pay [on time]."
Still, there's no absolute right or wrong way to have working capital, as long as your business always has it. When it comes to working capital, it's whatever works for you.
Read more articles on cash flow.
Photo: Getty Images
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