Businesses fail because they run out of cash. It’s the lifeblood of businesses great and small, new and well established. If your business runs out of cash, you won’t be able to pay your suppliers on demand, nor have enough working capital – the money you need to run your business day to day. Game over.
So what can you do?
Calculating how much working capital you have can help you to better understand how efficiently you’re running your business and how good its financial health is in the short term.
To calculate your working capital, you take away your current liabilities from your current assets.
| Current liabilities | Current assets |
| What your business owes to its suppliers and creditors. | Cash, any temporary investments, money you’re owed by your customers, stock, supplies – anything that could easily be sold for cash. |
How healthy are your business finances?
One working capital ratio, the “current ratio”, can tell you whether your business has enough cash to cover money it owes. You can work out yours by dividing your current assets by your current liabilities. A ratio of between 1.2 and two is good.
Anything significantly above two could mean your business isn’t making full use of its assets to drive sales and growth. You shouldn’t get lured into a false sense of security, because liquidating cash tied up in stock or materials can take longer than you want. Bad debts or late payers can also mean your business’s financial health is not as rosy as its working capital ratio would suggest.
A ratio of one or less suggests that your business has “liquidity problems” (ie is less able to access the cash it needs to pay its debts). So, what can you do to make sure you have enough working capital?
1. Control your costs
It’s key to remaining lean and efficient. It can help to ensure that you have enough cash to stay afloat. The less you spend, the less working capital you’ll need. Eliminate waste in all areas of your business. Don’t buy anything unless there’s a valid business reason. Don’t tie up too much cash in stock or materials. Negotiate fairly but firmly with all your suppliers and ask for best-value deals or explore other options.
2. Maximise your sales and margins
Are your prices high enough? You might be (unnecessarily) worried about putting them up, but even small price increases can make a big difference to your cash flow. Could you sell more to your existing customers? Have you explored all the ways to sell your products or services? What about new channels (eg selling online)? Which new customers could you target? What about customers overseas?
3. Ensure you have a robust credit control system
If you grant credit, any delay in sending out invoices will impact your cash flow. Include all essential details in your invoices and email them to the right person. Your customers should know your payment terms (30 days is standard). Be proactive when chasing customer invoices. Contact the customer shortly after sending the invoice to identify if there are any issues or disputes in advance of the due date that could prevent payment. Follow up prior to the due date with payment reminders. Be friendly and professional, but determined – it’s your money. By law, you can charge interest for late payment by other businesses.
