Questions that frequently come to our firm are about working capital. Some of the questions that come up are:
- What is included in working capital?
- What is important to manage?
- How do you finance working capital?
- What key indicators should you follow?
The simple definition of working capital is “the money available to run the business”. While that may be too simple, working capital includes cash, accounts receivable (A/R), inventory and other current assets. These items can be considered as things that you “own” in the business. The accounts receivable and inventory are things that consume cash and, therefore, are important to manage well. As your business grows, cash can be consumed in greater amounts by extending credit to customers and building stock.
Some business owners lose sight of the need to manage A/R and inventory and wonder where the cash went in the business. You should consider these to be part of your business “bank” and have processes in place to protect the assets.
Financing working capital is best done with a profitable business. Having a strong net profit from the sale of your goods or services will create the cash to finance the A/R or inventory until the A/R is collected or the inventory is sold. The next way to finance working capital is with credit provided by suppliers or vendors also known as accounts payable (A/P). A good rule of thumb is to always try to maintain an A/R balance higher than the A/P balance. There are other ways to finance working capital that can be detailed in a future newsletter.
If you would like to learn more on this subject, please give me a shout.