Working capital for your businessPosted on September 9th, 2012 under Wealth of Advice
By Francisco J. Colayco
Many of the advice requests I receive ask me how to start a business. However, there are those who already know what kind of business they probably can be successful in and want to start. One very important aspect of a business that should be studied is the working capital.
A start up small business usually fails to provide for sufficient working capital. Working capital is the cash that you need to pay for your expenses like payroll, rent, yourself and other bills in the course of your business while waiting for actual collections from sales. This is mainly because, most start ups tend to overspend on capital equipment and overheads such as rent, purchase of supplies, and furniture, construction of office, purchase of inventory, initial payroll etc. etc. Also, they are not able to anticipate the cash requirements before the business is able to attain a sustainable sales volume. Most of the time, collection time takes longer than anticipated and thus results in heavy cash deficiencies.
However, owners of businesses that are successful have lots of stories on how they went through so many problems. Many almost closed down but somehow have survived and have learned so many lessons in the process. One important lesson is to have a back-up plan for cash flow problems.
- If you can be prepared not to receive any cash inflow for a year and still continue your business, you are indeed very fortunate. Of course, you need to make sure that profits from your business profits are still enough even with such an assumption.
- In more cases though, you need to have a credit line available for contingencies. You could already have enough capital to put up your business (office and inventory are already in place) and are just looking for the safety net for possible short-term emergencies. In such case, your business may be acceptable to a bank or a financing institution for a line of credit. The bank might ask for your business assets as collateral. This line of credit is only to be used for times when you may need cash to cover a delayed cash inflow or an emergency cash outflow.
- If the bank cannot give you a credit line for your business, perhaps, it will give you a credit line on your individual capacity. For example you could use your personal assets as collateral.
When you already have a business set up, one of the major reasons for business failure is the lack of working capital. Many successful businesses go through a period or even several periods of hardship especially in the beginning. You need to be ready with a back up plan. Last article we talked about negotiating for a credit line with your bank or a financial institution.
If you can’t get a bank or financial institution, perhaps, you could go to an individual who might be ready to lend you money with your receivables as collateral. Make arrangements ahead of time so that you will not be approaching him when you are already in a hurry.
If you are able to get a credit line, use it even partially to be able to keep the account active and to develop a good credit history. Remember, Commandment No. 8 in my book, which is “Make money work for you; the power of leverage.”
When you use the money of others for a business that will earn you some profit, your returns are infinite. However, you need to be very sure that you will earn money because you will have to pay back what you owe whether or not you do earn.
Other than a credit line, you can improve your business cash flow by understanding how money moves in your business. You need to be able to know your possible problems much earlier so that you can prepare for it. You can either bring in your collections earlier or postpone your payables.
One way of bringing in your collections earlier is to offer discounts to your customers if they will pay you earlier than your standard terms. For example, if they will normally pay you in 30 days, you might give them a discount of 2-3% if they pay you in 15 days. There are many ways of doing this especially if you know your business and your clients.
An important rule in your own business is that you should pay yourself a salary. If you have been paying yourself and your business gets into a tight cash flow, your business could borrow from you temporarily. But remember that your business should pay you quickly. If your business cannot afford to pay you, you might want to re-examine your assumptions and perhaps, the business is not the right one for you.
Check out www.colaycofoundation.com for more info.