Cash Paid To Employees Is What Kind Of Cash Flow Working Capital for Business

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Working Capital for Business

One of the biggest needs that small businesses have is the need for working capital. Working capital is the lifeblood of a business, the fuel that funds day-to-day operations and the ability to pursue short-term business growth opportunities. Working capital is officially defined as “….”. The financial equation for determining working capital is as follows:

(Receivables + inventory + cash on hand) – (Payables + prepayments)

There are many sources of working capital for businesses. Looking at the equation, one way to get additional working capital is to increase accounts receivable (ie, more sales) or to convert accounts receivable into cash by getting customers to pay more quickly. Continuing to study the equation, another way is to increase inventory. When reviewing a company’s balance sheet for the purpose of acquiring that company, it is important to examine how these parameters fluctuate as part of working capital. A company can significantly increase inventory and accounts receivable, which drastically increases the amount of designated “partial capital.” However, these receivables could be essentially uncollectible and inventory obsolete. Both would essentially negate the benefits of a large “partial capital”.

You can access cash by persuading customers to pay for their orders in advance by offering significant discounts for doing so. For example, if a customer buys a monthly service for $100, you can offer them an annual pre-paid discount of $1,000. That’s about a 20% discount, but when you consider the time value of money, the discount drops to 5-8% (depending on your internal rate). If you are selling much larger service contracts or products, the difference in actual money can be huge with prepaid payments. On the other side of the equation, you can get the supplier(s) to extend the terms. Instead of a payment expected in 15-30 days, you may be able to postpone payment for 90 days. You never know unless you ask.

From the point of view of the business owner, the higher the share of working capital in money, the better. You can use the money for anything – to pay suppliers, pay employees, pay rent, pay for geographic expansion or product line development. Accounts receivable and inventory that do not convert quickly into cash through turnover must be converted into necessary cash through financing that uses either or both as collateral for loans.

Working capital for businesses is something that many small business owners don’t plan for. They often don’t think about it until they run into a financial crunch. But sometimes they don’t, until they run into multiple cash crunches and get tired of the stress of not knowing how they’re going to make payroll or pay angry suppliers.

Some of the myriad sources of funding working capital for businesses include short-term asset-based lines of credit, long-term loans, equipment loans, signature lines of credit, supplier financing or extended payment terms, economic development grants, and factoring. Typically, accounts receivable and inventory loans are short-term lines of credit that can be renewed annually. Some banks and other financial institutions will extend the loan for three to five years with a high rate of collateral. (ie accounts receivable that are typically paid within 30-45 days and are with very creditworthy customers and inventory that is replaced in a similar time frame.)

It is important to constantly be aware of what “partial capital” is and what goes into it. It is vital that you keep track of your business cash flow and how quickly your business turns its short-term assets into cash. Failure to do so may result in a significant shortage of working capital and, in the short term, a liquidity crisis. If your business qualifies for a line of credit, get one. You don’t have to use it, but you should have it on hand to use in case of a crisis. I have had clients who lost large clients due to bankruptcy. This unfortunate scenario happened more often in 2010 and 2009 than in previous years, but it can happen at any time. If your customers have large outstanding receivables that are close to 90 days, your exposure to such a scenario is drastically high. Even if your risk is low, when a customer can’t or won’t pay their receivables on time, where do you get the money to operate while you deal with the problem? Plan for the future and monitor your working capital. Your business will thank you for it in the form of stronger financial health.

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