To truly take the pulse of your business, you must be able to manage your working capital and understand your working capital requirements. It’s a fundamental building block for the financial health and operational success of your business.
What is working capital?
Working capital is defined as the capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.
Manage your working capital
What is your current method for managing the cash coming in or going out of your business? Are you falcon-like, with a keen proactive eye for detail? Or do you behave like an ostrich, sticking your head in the sand until you’re forced to react?
Don’t despair. A reactive working capital plan is more common than you think. But this strategy may well end in disaster because, as most seasoned business owners know – there is always something you failed to anticipate. While you need to be proactive and think ahead, there will always be things you don’t know – or can’t predict.
What is the impact of not planning working capital?
The biggest knock-on effect from not planning your working capital requirements is that you don’t truly understand the position of your business. Without such forecasting, you simply can’t be sure of your business’ overall financial health and ongoing resilience.
When you don’t know what’s coming, you’re likely to end up encountering issues with day-to-day operations. If you misjudge the amount of incoming cash, you could struggle to pay staff or purchase essential inventory. Which leads you to a position where you are attempting to raise funds under serious pressure – bad for your health, as well as your chances of getting a good deal. That’s because most lenders will interpret surprises as a result of poor cash control and are thus less likely to extend funding to your business.
Benefits of planning ahead
With a solid working capital plan in place, you can make sure your business stays flexible. To capitalise on growth opportunities or to cope with unexpected shifts in the market. Extra cash can help you to bring in some additional inventory, update your equipment or perhaps extend payment terms for a customer, without damaging the overall financial health of your business.
With that flexibility, comes a competitive advantage. You can be more aggressive in pursuing new opportunities and exploiting potential gaps in your market.
However, the underlying benefit is much simpler: peace of mind. Your business is in a stronger position when you are financially prepared with a solid base of working capital.
How to plan your working capital
- Always plan for the big picture, because separating working capital at a granular level can cause problems. Different functions of the business are working on different schedules and priorities. Your procurement team may be seeking to reduce costs through consolidated shipments, which could be working at cross-purposes to a finance team trying to preserve cash in the bank.
- Cross-functional communication is essential to determine what’s best for the company as a whole.
- Keep things dynamic. The financial situation for any business is always changing, your approach to working capital should not be ‘set and forget’ . For example, it might be that your cash forecast has changed dramatically due to the loss of a major client. You should update your plan at least once per year – and check in with regular reviews to evaluate progress against the plan.
Modus & Finpoint
Here at Modus we work with Finpoint. They are free to use and 100% transparent about fees and rates. We use Finpoint because they give you access to the UK’s largest panel of business lenders and are 100% independent.
Want to know more? Speak to Finpoint about funding or your financial planning needs.