Working Capital. Do you have enough?
One of my favorite topics when it comes to helping small business owners
is working capital. So, what exactly is working capital?
Working capital is the money you have in reserve for your business. It is the money your business works with on a daily or monthly basis.
The rub with working capital is if your business has enough of it or not. Do you know the seasonality of your business? Are there months that your business brings in more money than others? If you don’t know your business seasonality, print your profit and loss statements by month, and check out the increase and decrease. This will help you determine how much you need to save to survive during your low months; that cushion will help to decrease your stress when the low income months occur.
What is the flow of income for your business? Do you get paid on the first of every month, once a week, or are you paid daily for your service or product? When are your bills due, rent, payroll, electricity, gas, power, Internet? Working expenses usually roll in every month in one chunk, and usually at the beginning of the month. It is best to bring income in and pay bills as they come, but to still reserve for the following month. This reserve will help you to pay the bills that come towards the end of the month, just as the next month begins. Having a working capital, or money reserve, will help you be able to pay those bills as they come up.
The litmus test is, at year’s end, are you in neutral or above and you can pay yourself and profit, or are you needing to pump money in? If every month you find yourself borrowing from Peter to pay Paul or waiting until the last minute to pay bills, or at the end of the year you have a loss, you most likely have a cash management problem.
Are you spending to zero, meaning your working capital account has a zero balance? Part of how you build a minimum reserve for your business is to protect yourself by having a savings account. This savings can help pay for emergencies, unexpected expenses, and the expected items, such as taxes. Lastly, instead of spending to zero, begin to spend to priority. Create a finite list of bills and prioritize them, employees, rent, etc. This list should be all the things that if you don’t pay them, the doors of your business will close. Have a due date on each thing on the list and when they’re due, pay the priorities first and then the variable expenses. Only pay those that have the highest priority and catch up with the others during your higher income months.