Many small business owners don’t understand or appreciate the need to have a good handle on working capital and how it is generated or consumed by the business. Let’s take 2 examples on opposite ends of the business spectrum.
First a Day Spa. At a day spa the customer comes in, pays for the services and then gets the services – no accounts receivables to collect…no money, no service. Also, a Day Spa sell lots and lots of Gift Certificates. With gift certificates the biz collects $100 for a gift certificate and has the cash for weeks, months, years or even forever before the service is delivered. That’s called negative working capital. I get your money before I incur the cost of providing the service.
Now lets look at an office supply business. A customer calls up, orders 5 cases of paper for delivery at a cost of $200 and the customer wants you to “bill” them. Which means they will pay in about 30 days. This $200 order requires a lot of working capital…you had to buy the paper, pay the driver, pay the person who took the order all BEFORE the customer pays you the $200. All those expenses you had to pay out before the customer paid you needs working capital to pay.
That’s why understanding working capital is critical, if you are in a business that needs working capital to grow you’d better figure out where the working capital is coming from before you start to grow. Many. many profitable businesses have gone out of business because they didn’t account for, and plan for, the working capital needs of the business.