|Every business needs to ensure an
adequate supply of cash. Run out of cash and it's over. Period.
The textbook definition of Working Capital
- Current Liabilities
You can get your current assets and
liabilities right from the balance sheet without going through any other
manipulations or calculations. The Working Capital number tells you if you
have the liquid assets to satisfy near-term liabilities. Again, this is
the textbook approach to determine Working Capital.
But for a small business owner, what's
better is a more comprehensive yet still practical approach to determining
how much cash you need. Working Capital is a good start but other factors
come into play, including fixed asset purchases, so a more complete way of
projecting cash flow is needed.
There's no substitute for doing a future
cash flow forecast by projecting the next 12 months' cash inflows
(including loan proceeds) and outlays (including principal and interest
The way to do this: Set up a simple
spreadsheet that starts with beginning cash balance. Each month, add cash
in and subtract cash out to come up with an ending cash balance. This in
turn becomes the beginning cash balance for the next month, and so on.
||And so on
You'll want to expand the "Cash in" and
"Cash out" categories so you have more detail. For instance, cash comes in
from receivables collection and from such sources as drawing from a bank
line of credit. Cash goes out to vendors, paying down your line of credit,
etc. You get the idea. Use enough detail to paint an accurate picture of
cash in and cash out.
Don't forget to take into account what
portion of sales are on net terms and how long on average customers take
to pay, how long you take to pay payables, how long inventory sits on the
shelves, fixed asset purchases, etc. Non-cash transactions (like
depreciation) also need to be handled and calculated appropriately.
This approach requires you to estimate
both sales and expenses going forward. Be conservative in your estimates!
If you think sales will be $50,000 and you'll get paid in 35 days on
average, you might consider using $45,000 for your sales estimate and 45
days for your receivables collection period. I'll say it again: Be
conservative in your estimates!
Yes, it requires work to do this. Many
entrepreneurs would prefer a simple formula - like the Working Capital
calculation above. But a formula can't adjust for business seasonality and
all the other inflows and outflows that come into play, so there may well
be specific periods of low or no cash that don't show up in a formula.
Take the time to set this up and use it every month.
Bill Collier is a St. Louis-based business coach, consultant and speaker.
He is the author of the book “How
to Succeed as a Small Business Owner … and Still Have a Life.”
His website is www.collierbiz.com,
and his email is firstname.lastname@example.org