Working capital equals current assets minus current liabilities and is important because positive working capital is necessary to run a business successfully. Without positive working capital, where more cash enters the business than leaves, a business will die.
Current assets are things a business possesses that are or can be turned into cash within a year or less. Examples are cash, marketable securities, bonds, accounts receivable, inventories, and equipment. Accounts receivable are a result of sales and a list of clients that have received a business’s product or service and promised to pay for it at a later time; usually within 30 to 60 days from receipt of the product or service.
Current liabilities are things a business must pay in one year or less. Examples are accounts payable to vendors, labor, rent, utilities, lines of credit, and other debt payments due within a year. Accounts payable is a list of vendors the business owes for raw goods, materials, and other items necessary to deliver their products and services for sale.
Often, an entrepreneur will plunge into business because they are passionate and or good at something. This is a strong start but sometimes the management skill necessary to facilitate healthy fiscal outcomes is secondary to follow. A business owner’s job is to manage the cash of their business first, then, if there is a business reason, pay vendors early; an important balance. It is common for strains on cash to occur as a company tries to grow because dollars are needed for a lot of things like payroll, owner salary to keep his/her personal bills current, rent, taxes, utilities, marketing, funding new sales opportunities, acquiring machinery, and inventory. All of these items require cash. A less experienced business person might put the majority of their focus upon paying people. This is a mistake.
A business owner must concentrate on making sales and collecting those sales. One of my favorite things to hear from a client is when talking about accounts receivable on sales made to customers is, “That is my money. If I do not collect it, I have nothing. Nobody pays me a salary.” Again, I love to hear those words because cash from collections can be used to stay in business by satisfying ongoing obligations to third parties and compensating the business owner for their time and effort.
It is remarkable that a large percentage of businesses fail before having the chance to begin. The main culprit is understanding a business’s working capital need. In a perfect world, everyone wanting to start a business should figure out their cash needs for the first year or two and one of two things would happen. One, they would be successful faster knowing when and where to begin as critical factors lined up. And two, many business failures would be prevented as an entrepreneur decides to not jump into a particular business. -Sometimes a person is better off as an employee. I can say this because, many times over, I have seen the ups and downs of owning a business.
Jim Stanley freely shares his knowledge in an effort to foster economic development success in Indian Country. He is a tribal member of the Quinault Nation, Treasurer of the Tribal C-Store Summit Group, board member of the Northwest Native American Chamber and Quinault Nation Enterprise Board.