What is it?
Simply put, it’s how money is used in the business. The money you get from sales is used to pay suppliers, which allows you to get more stock (on credit), pay the running costs of the business, and hopefully you. If the business is growing there is a need to make sure that you collect in enough to fund the extra stock you need for more sales and therefore bigger supplier payments.
Why it is vital
You always have to balance the need to sell more and so earn more with the need to be able to pay people on time.
Businesses go bust when they run out of cash, not because they are unprofitable.
It’s quite easy to make a lot of sales and profit and still go bust. The faster you grow, the greater the risk. It’s called overtrading. Tuning Working Capital is key to survival.
You come last – sorry!
As a business owner, it means you don’t get to spend the extra profits you are making from your growing business until the rate of increase in sales slows down, as you will always need more cash to fuel the Working Capital cycle. It can seem like you are working harder for nothing, but that’s not true – your accounts will show you that you are doing better, and you should be able to make a guess when you can increase your drawings from the business to reward yourself. You will need to manage your own expectations.
What should happen is that you, the owner, should get the biggest slice of the cake. However, it’s always the last slice of cake. Making sure you get the biggest slice needs constant attention as does making sure you regularly get enough to eat.
What if we don’t sell “stuff”?
This is still relevant if you have no stock, or what you sell is your time or the time of your people in one form or another. Here, instead of stock and suppliers, you have the capacity (stock) of time and resources that you need to balance against the changing needs of customers.
Estate agents have no stock or sellable time, but they have properties for sale. They need to increase the stock of these to generate enough interest to sell them, and that takes time and money. And there’s the time that the estate agent has to spend in selling the house and making sure the sale goes through. It’s still a matter of capacity, just like physical stock.
So, every business will have something that primes the pump that generates sales. You will know what this is in your business.
A service business, selling time and resources, has more difficulty in adapting to changing demand than a business which sells things. This is because the physical stock tap can be turned on and off much quicker. The service business may have to take on more people in the hope that their time can be sold quickly enough to at least make up for the extra cost. They’ve taken on a fixed cost. It may be better to subcontract until demand has built up, to avoid having the difficulty of never filling the new capacity and having to lay someone off (more on fixed and variable costs in a later blog). Flexing stock levels to match demand is much quicker and cheaper, and it’s always a variable cost.
Tuning Working Capital
There are only a few ways of managing Working Capital (WC), but it does need constant attention else something slips. Your cashflow will be impacted. So will your peace of mind.
Get better credit terms from your suppliers – pay them slower. This frees up a one-off benefit to fuel more growth. One-off because if you suddenly get 60 days credit on an extra £10k instead of 30 days, you have another £10k for a month every month but no more than that.
Get customers to pay quicker. Again, it fuels growth, and it’s a one off. It also cuts your risk of a customer leaving you with a bad debt.
Ask for discounts
If you’re in the lucky position of having a healthy bank balance, ask your suppliers for a discount for paying them early. Another 5% off your direct costs, straight to bottom line profits, is a big benefit. If your costs of sales is 50%, and you can get 5% off, that’s 2.5% extra profit. Whilst it doesn’t sound a lot, think of what you have to pay out of it. That extra 2.5% could double your fun money – what you get to enjoy, rather than just pay the household bills. Also have a look at The Secrets of Pricing for Profit and 14 ways to charge more if you want to get a bit more creative.
Turn the wheel
Turn the WC wheel faster – manage stock/people such that you utilise those assets quicker – it’s about stock turn (how quickly you sell your stock, or time) and how often, so that means minimum stock for maximum turn. Coupled with good credit terms and quick customer payments terms, this spins the wheel faster, so you get more profitable sales paying you quicker from the same amount of WC. This is the key to continual improvement.
- Workout the workflows.
- Workout the proceduresto ensure that the workflows happen.
- Organise trainingso that people follow the procedures.
- Design a monitoring
- Set up your accounting
It’s all in 5 steps to scaling your business. Whether you want to scale or not, these steps make your business easier to control, more profitable and more predictable. And it means you can turn that WC wheel faster. It’s the equivalent of gears on a bike. Do you want a bike where you have to pedal more to go faster? Or would gears help?
This blog is an excerpt from the upcoming e-book Understanding the Numbers by Nick Hixson, which will help you improve your ability to fix common issues. And you don’t have to learn bookkeeping first. Look out for more blogs showing how to turn fixed costs into variable ones, so reducing risk, and there’s one on direct and indirect costs which help you with pricing.
At Hixsons we make sure our clients are agile, flexible and resilient so that they are better able to respond to shocks. You can also read the helping in a crisis stories of how we helped 6 local businesses turn things around in the early days of the pandemic.
In the spirit of helping our business community we have helpful resources in our learning centre where you will find various tools and templates for your business. We do not ask for your data, and it’s completely free.