Empower Your Business

Accounting is Just the Beginning

By

Keys to Business Success – Adequate Working Capital

Keys

They say that over 60% of businesses that go bust are still profitable. I’m not so sure about that myself but one way or another, lack of working capital is a major cause of business failure. But well before that, and especially on set-up, having enough working capital is absolutely vital in business.

Normally, there are only three sources of working capital available for small to medium businesses:

  1. Owner’s Funds. This could be funds initially invested into the business on set-up, or monies subsequently loaned to the business, maybe from undrawn remuneration.
  2. External Borrowing. This could be from banks, relatives, or finance companies.
  3. Retained Profits. These are undrawn profits from prior years, the cheapest and best source of working capital.

It doesn’t matter which source you use, providing overall you have enough available to fund your business. Even a well-run small business requires a substantial amount of working capital, but if the management of that business is sloppy e.g. inventory or accounts receivables levels get out of control, the amount of working capital required will balloon to impossible levels which, after a while, will inevitably lead to a business crises.

So what can you do to safeguard your working capital?

  1. Never underestimate the working capital required in a business.
  2. Always use cash flow forecasts to forewarn of periods of peak demand.
  3. Make sure you have adequate reserves of working capital, whether cash in the bank or an under-utilised borrowing facility.
  4. Keep on top of the management of your business at all times. If, for example, you slip behind on invoicing or don’t collect your debts it will soon run away from you.
  5. Make sure you use decent accounting software (nowadays as cheap as chips) so you can keep track of assets and liabilities.
  6. Restrict your drawings to a level which allows the accumulation of retained profits. There is an obvious and strong relationship between the level of drawings and retained earnings!

Managing your working capital well is a key business skill. If you need help with yours contact nick on 0800 ASK NICK or nick@abac.co.nz.