Working capital is essential for paying everyday expenses, but just how much working capital does a business need? And how does your business model affect how much you’ll have available?
Assessing the amount of capital you need – and ensuring that you have it available – is essential to ensure your business can keep growing.The biggest factor affecting your working capital is the liquidity cycle, the length of time between your business paying its costs and it receiving income. Different business models will go through this cycle at different speeds and lead to a greater or lesser amount of working capital being available at any one time.
At their most basic, many businesses will follow a similar pattern: they will produce goods, sell them, receive cash, and then use the money made to pay creditors, pay wages, and invest in the ability to produce more and better goods.
The speed with which this cycle, and each stage in it, happens, significantly affects the amount of working capital that businesses have available to them. More specifically, the following two factors have the biggest effect:
The Speed With Which Money Changes Hands
The speed with which you receive money from your creditors, and how quickly you need to pay your suppliers, can boost or reduce your working capital.
Ideally, you will receive money from your creditors quickly, but have long credit agreements with your suppliers. This should result in your business having working capital to hand when you need it.
The opposite can also be true – if you have to pay your suppliers quickly, but receive money slowly, you may find yourself with very little working capital. If you’re paying back your suppliers long before you ever receive any money for goods, your available cash will be taking a large hit.
This can be a particular problem for newer businesses because without an established reputation they are often given short payment periods
The Time Taken to Sell Goods
For businesses with physical goods, the time between purchase from suppliers and products moving off the shelf can impact on the speed of the liquidity cycle.
When you have a lot of goods sat on the shelf not selling a lot of your capital is wrapped up and unavailable for use. Of course, businesses that sell services or digital goods don’t need to worry about this.
Does Your Business Need More Working Capital?
A high amount of working capital ensures that your business can always pay its creditors and staff and that you have money available to take advantage of any opportunities that come your way. Businesses that are low on working capital can overcome this with a working capital financing.