If you have a business, you will be familiar with working capital. Depending upon your business model, it may not be an issue, or it may be vital to your very existence. At it’s simplest, working capital is the short term means required in order to trade. It is made up of four basic elements:
If you start a business from scratch, selling say widgets, you will have to buy stock in order to trade. You may give credit to your customers. They may take longer to pay than you anticipate. In the meantime, the suppliers who sold you the goods - your creditors - may want paying. And whilst all this is going on, you may incur overheads for running your shop (wages, rent, light and heat), promoting your business, and if there’s anything left, something for you to live on.
This is what we mean by working capital. In the example above, it is likely that funds will have to be pumped into the business via the owner, a bank loan, or an overdraft.
You can see how not having the cash to begin with can seriously damage your business model. You may not be able to hold a lot of stock, or give customers credit (in which case they may go to your competitors), or pay your suppliers (in which case they’ll stop supplying you).
Of course, your business model may not need a lot of working capital. If you provide a service, you may just need sufficient to pay your overheads whilst you wait for your customers or clients to pay you.
Or you may trade over the internet and not hold physical stock, only ordering when you receive an order (and payment) from a customer.
There is a classic quote in business – cash is king. This is fundamental to your working capital requirement. If you have customers who don’t pay, the business may be starved of cash to settle debts.
When a business starts up, it should complete a business plan. This will include a forecast profit and loss account, balance sheet and cash flow forecast. The cash flow forecast is important as it will look at your working capital requirements, and see, amongst other things, whether you have any funding requirements.
Hopefully, the above points may highlight some of the issues involved in trading and how they can have a significant effect on a business's viability.
