Working capital is a measure of both a company’s efficiency and short term health. It is the difference between current assets and current liabilities and it highlights whether a company has sufficient assets (cash flow) to cover its short term debts. Many believe that a working capital ratio of between 1 and 2 is the appropriate range.

Earning extra money

As a business owner, manager or director, you have a responsibility to ensure that the business has enough money to settle its debts as and when they fall due, but you don’t want to have too much of an excess either. The working capital cover ranges from business to business and from circumstance to circumstance. For example if you operate in a company sector where suppliers offer three month’s free credit with no early settlement discounts, then there is not much point in settling your debts early unless you have fringe benefits, such as you can call on favours for say quick supplies in the future if you need them. If on the other hand immediate settlement delivers a significant discount of off your bills, then go for it and pay early if you can. This extra profit goes straight to the bottom line and effectively is money for old rope. Far easier earning it that way than by sweating!

Up against the wall

Don’t fall into the trap of having to speak to the bank manager every day, update daily cash flow forecasts, pleading with suppliers. If you find yourself in this position, you are in desperate straits and unless help comes soon, you are likely to fail. Your time is being taken up with rubbish and is better spent on running your business.

External finance

If you have a profitable company, but your personal and business finance has come to an end, think about raising external capital. This could come from a potential new business partner. Remember equity does not attract interest! You may need to issue some shares in your new business in exchange for a cash injection into the company. This is not the same as you selling some of your existing shares, where the money goes to you, although it could be, since you could lend the money (on an interest free or otherwise basis) to the company yourself. There are different tax implications for these transactions and advice should be sought from an accountant of you are thinking of going down these lines.

You always need a bit more than you think

Business does not operate in a straight line fashion. Companies have highs and lows. There are seasonal fluctuations and unforeseen circumstances that cannot possibly be predicted, such as a new competitor entering the market with rock bottom prices. Living life on the financial edge is not what you want or need. Speak to your accountant; prepare a simple “top line” short term budget for 3 to 6 months and a longer term one, perhaps for 3 years. Listen to the results and don’t hide your head in the sand.