Do you have plans to grow your small business? Are you trying to figure out just how much cash you need to put those plans into action? Working capital is the lifeblood of any company and is essential for the smooth operation of your small business. Because working capital has a direct impact on your business’ cash-flow and ability to expand, it is important to have a strong understanding of what it is and how the working capital cycle works.
What's Working Capital?
Working capital refers to the difference between your business’ current assets and its current liabilities. It is the amount of available capital for daily operations at any given point of time. The most common ways in which business owners choose to use their working capital include: covering day-to-day expenses, purchasing inventory and equipment, hiring and training new employees, creating a cash cushion for unforeseen situations and funding plans for expansion.
If your business experiences negative working capital (more liabilities than assets) over an extended period of time, it can put your business at risk. Some of the many disadvantages to negative working capital are bankruptcy risk, missed growth opportunities, a lack of investors and a bad financial reputation. On the other hand, if your business enjoys positive working capital (more assets than liabilities), it is considered to be in good financial health. When your business has adequate working capital, it communicates that your business is performing well and that it is being managed efficiently.
The Working Capital Cycle
The working capital cycle for a business is the length of time it takes to convert net working capital (current assets less current liabilities) all into cash. It reveals how much working capital it really takes for your business to run smoothly. The longer the working capital cycle is, the more time your business’ capital is tied up without earning a return. The shorter your business’ working capital cycle, the more effective it is. The elements of working capital include: inventory, accounts payable and accounts receivables.
- Inventory – Inventory will show you how long it takes for your business to sell your goods or services
- Accounts receivables – Receivables show how many days it takes for your business to be paid
- Accounts payable – Accounts payable reveals how long it takes your business to pay its suppliers.
Ways to Optimize Working Capital
The overall goal of optimizing working capital is to ensure your business maintains sufficient cash for daily operations. Even the smallest of changes in working capital management can have a positive impact on speeding up cash-flow. The following are just a few of the many ways your small business can optimize its working capital:
Inventory planning allows you to determine the optimal quantity and timing of inventory. Your goal should be maintaining enough inventory to avoid a negative impact on revenue, while also minimizing it enough that it does not tie up vital working capital or become obsolete. Closely monitoring inventory and optimizing inventory days (the amount of time between storing inventory and when it is sold) will help you improve your small business’ working capital.
Speed Up Receivables Collection
The efficiency (or lack thereof) in processing orders, deliveries, the number of returns, and creating invoices correctly all impact accounts receivable. Take a closer look at your business’ invoicing cycle. The key to speeding up the collections process is to set clear payment terms, provide multiple payment options, know what your customer requires on invoices, stay on top of your accounts, start collections early, and send out statements monthly – make the process as convenient for customers as possible.
Seek Additional Working Capital
Many businesses require financing to cover the period of time between completing an order and receiving payment from customers. Invoice factoring, for example, allows your business to speed up the receivables process and secure the working capital you need quickly. Seeking additional working capital not only provides your business with the ability to purchase supplies and cover payroll, but also the flexibility to accept new business opportunities.
What is your business’ working capital cycle telling you? Make sure your working capital is working for your business, not against it. All in all, the reward of optimizing your working capital is that it frees up cash, so your small business can continue to thrive and grow.
Security Business Capital’s Business Funding Solutions
Security Business Capital, based in Midland, Texas, is a premier invoice factoring company with years of experience. The team of experts at SBC specialize in helping companies secure the funds they need to operate smoothly, grow their business and take advantage of opportunities. SBC’s invoice factoring services, for example, allow you to use unpaid invoices to easily secure the cash your business needs. Oil and gas service companies, transportation, temporary staffing, distribution and manufacturing, business services, and government are just a few of the industries that successfully use invoice factoring services.
To learn more about Security Business Capital’s invoice factoring option (or our other service options, like purchase order funding), contact SBC for a free quote and/or consultation.