If cashflow is the lifeblood of your business, then working capital is the health check you should have regularly to keep your business alive.
Working capital measures the surplus (or deficit) you have to keep your business afloat without needing to sell assets, borrow more, or add your own money in. The more working capital you have, the easier it is to fund growth or weather any downturns.
Use the following formula to calculate your working capital:
Cash + debtors + stock + work in progress – creditors – taxes owing
For example, if your business had the following balances:
Cash = $150,000
Debtors = $120,000
Stock = $100,000
Creditors = $45,000
Taxes owing = $25,000
Then your working capital would be $300,000 ($150,000 + $120,000 + $100,000 – $45,000 – $25,000).
If the business had an overdraft of $150,000 rather than a positive cash balance, the working capital would be zero. This means the business would have no cash to cover any slowdown in debtor payments or a downturn in sales (which would lead to higher stock levels). Worse, the business could be in serious trouble for trading while insolvent.
To increase your working capital, consider the following strategies:
1. Have enough cash to cover at least 2 months’ sales value.
Calculate the amount you’ll need, using the average sales value for the last six months, then make sure you have at least this much cash on hand at all times by strictly managing your expenses.
2. Inject sufficient funds.
Invest your own funds into your business to cover your working capital requirements.
3. Renegotiate your debt.
For example, any ‘core debt’ element of your overdraft could be negotiated into a term loan. Note that ‘core debt’ refers to the average lowest value of your overdraft over the last 3-6 months (i.e. the amount you haven’t paid off each month).
4. Negotiate with suppliers.
Ask for more favourable terms with your suppliers. Note that this does not mean not paying your creditors when they fall due!
5. Set aside money for taxes.
Calculate the percentage of sales you need to put aside for taxes and put this in a separate bank account so you have the cash to cover tax payments as they fall due.
We can help you calculate your working capital requirements and identify strategies you can implement to increase your working capital.
“Change is not a threat, it’s an opportunity. Survival is not the goal, transformative success is.” – Seth Godin
This information does not constitute financial or legal advice and is for general information purposes only. Please contact DLA Partners for specific advice relating to your particular circumstances.