And as it’s a meaty topic this is part one of a two part blog.
What is it?
What it really means is, how much cash have you got tied up in your business, and have you got enough cash to pay your bills as they fall due?
This is the most technical I’ll get here, it’s made up of
- Your current assets: your stock + work in progress + debtors + cash,
- Less your current liabilities: creditors and anything else due for payment within 12 months.
This tells you if you settled everything up, would you have spare cash. It’s a key measure of your liquidity and how well you can meet your bills on time.
There are three main components to your working capital – this is where all your cash is tied up.
- Stock / work in progress
- Debtors
- Creditors
Why it’s so important to your business
Good working capital management can be the difference between a financial distressed company and a profitable one. With funding harder to come by these days, it’s never been more important to have a tight grasp of it to make sure your business is solvent.
Don’t dismiss this as something that only affects poorly trading companies, overtrading is a killer that can easily get you if your business is growing. This is where the term “going bust with a full order book” comes from. As your business grows the amount of working capital also grows, so you need to be really aware of this, and where the cash is going to come from.
If you can’t pay your bills on time there’s a possibly you’re trading insolvently, which not only can destroy your business but also has hefty penalties including prosecution and disqualification of directors.
And having constrained working capital will continually hinder your ability to grow and develop your business; you’ll never quite afford do the things you want or take advantage of opportunities.
What isn’t it?
This is my big bug bear. It absolutely is NOT your vat or corporation tax. Every month you should put your vat and corporation tax estimate on that month’s profits into a separate bank account. You should never use the vat you’ve been paid, or this year’s corporation tax as part of your working capital. It just isn’t your money and so should never be used to pay bills.
What information do you need to manage it?
You can improve your working capital, once you know what it is, and get simple information every month to make sure it’s under control.
There are two key questions:
- How much cash is tied up in your business?
- How can you free up more cash?
Weekly
- Make sure you see your debtors and creditors report every week – take note of anything over terms and put pressure on to keep the customer’s payments coming in on time. Are creditor payments building up, why aren’t they being paid on time?
- Look at your rolling 13 week cashflow every week – are there any pinch points?
Monthly
- As part of your management accounts you need to see graphs of your working capital – in total and the components of debtors, stock and creditors. Numbers in isolation mean very little so you want to look at the trend.
- You also want debtor days and creditor days as part of your KPIs so you can spot when they go up.
- Look at your balance sheet at the line called “net current assets” make sure it’s going up and not down. Put this figure on your KPIs as well.
Stay tuned as next week I’ll be showing you ways to improve your working capital and cashflow.