We help technology intensive businesses (design & marketing agencies, IT services companies, software developers, etc.) grow their revenue and manage their costs – so where does working capital improvement fit in? I am not an accountant and most senior directors of my clients are similarly placed, but the lack of understanding of working capital is the main reason why service businesses are constantly starved of cash.
I like to sleep at night and I have learned the hard way that the shortage of working capital is the major cause of cash problems in any business. An accountant will say that it is the financial measure that dictates a company’s operating liquidity – I would say it is the amount of cash available to operate your business day-to-day. It can cause a business to fail to meet its payroll at a month end, or not pay its suppliers as agreed.
Most directors and business owners accept that “cash is king”, without realising that tight management of working capital is the foundation on which to build positive cash flow. It is often the least understood and most poorly managed area in the company.
Yes most business owners understand the significance of working capital and working capital ratios – but only from a short term bank balance perspective. They think about the component parts of working capital (debtors, creditors, stock or work-in-progress) to give a quick snapshot of cash availability for the next month or so. Great I can sleep tonight and I can now shift focus away from working capital, and look at marketing, sales pipeline, recruitment, etc.
But, if you don’t stay on top of it, it will come back and bite you when you least expect it. When running a service business, when to be honest most of your assets have 2 legs and 2 arms, and leave the building every night, if you want to grow attention moves to other areas of the business. This gives rise to the deterioration of cash flow, which in turn adversely affects a company’s ability to fund its operations, reinvest in the business and, ultimately, to survive.
So how much working capital do you need to grow your revenue and profits? The amount of adequate working capital varies between a small business and a large business, between an under-capitalised company and a well-capitalised company, between a growing business and one declining. What is scarier is that it can vary significantly from one day to the next.
So how should it be managed in your business?
Answer – the Cash Conversion Cycle, giving any business owner visibility of working capital.
This measure offers an accurate and strategic view of your working capital requirement, and is fundamental to cash flow improvement. It gives you valuable clues about the underlying health of your business model.
The value of the Cash Conversion Cycle lays not so much in the single number, e.g. 90 days at a single point in time. This is just the starting point, but it can be compared against the norms for the industry in which your business operates.
The next blog will go into the details of how to perform the calculations around the Cash Conversion Cycle. More importantly what you as a business manager do to improve the working capital and get the relevant parts of your business to focus on the cash – so keep coming back here for more. Or if you cannot wait and want a free discussion with Phil about the specifics relating to your business them call or email directly our details are here.