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Manage Your Working Capital for Success

May 28, 2009

As the owner of a small business, you may think it has little in common with a large corporation. While it is true that you will likely rely more on trade credit, bank financing, lease financing and personal equity, your long-term investment decisions require the same kind of analysis used by large firms. The key is understanding those factors that affect financial decisions, how they apply to your business’s short- and long-term goals and strategies, and any other influences that may be unique to your situation.

Working capital is the difference between current assets and current liabilities. Lack of close control on working capital is one cause of business failure. The small business owner must be constantly alert to changes in working capital, the reasons for them, and any resulting business implications.

Think of working capital in terms of its six components:

  1. Cash and equivalents. This most liquid form of working capital requires constant supervision. A good cash budgeting system addresses many important considerations: whether the cash level is adequate to meet current expenses as they come due; timing of cash inflow, cash outflow and peak cash needs; amount to borrow to meet cash shortfalls; and, the timing of repayment of loans.   
  2. Accounts receivable. Almost all businesses extend credit to their customers. Make sure the amount of accounts receivable is reasonable in relation to sales and that receivables are being collected promptly. Identify slow-paying customers and have a strategy for dealing with them. 
  3. Inventory. Inventory often constitutes as much as 50 percent of a firm’s current assets. Is the inventory level reasonable compared with sales and the nature of the business? Know the rate of inventory turnover compared with other companies in your type of business. 
  4. Accounts payable. Financing by trade is common in small business and is one of the major sources of funds for entrepreneurs. Understand whether your business’s payment policy is helping or hurting your credit rating. Know the timing pattern between payment of accounts payable and collection of accounts receivable. 
  5. Notes payable. Notes to banks or other financial sources represent a popular alternative financing source. Look at whether the amount of borrowing is reasonable compared to the equity financing of the firm. Keep track of when payments are due and whether the money will be there to make these payments on schedule. 
  6. Accrued expenses and taxes payable. These are obligations of the firm at any given time and represent expenses already obligated, even if payment is not yet issued.

 To discuss business financing, understanding financial statements or budgeting, contact SCORE Lancaster “Counselors to America’s Small Business.” SCORE is a nonprofit organization of more than fifty expert business counselors who provide free and confidential advice to entrepreneurs. Call us at 717-397-3092 or find us online at http://www.scorelancaster.org.

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