Working
Capital an
Explanation
The
following
article is
written to
give you an
elementary/simplified
understanding
of working
capital, so
as to allow
you to avoid
some of the
more obvious
pitfalls.
Working
capital is
part of the
Balance
Sheet
(some say
the most
important
part, I
would not
disagree).
Working
capital is
the money
and assets
(excluding
fixed assets
i.e.
buildings,
machinery)
that a
business
uses to
finance the
day-to-day
operations
that produce
the goods or
services
supplied to
customers.
Working
capital is
also the
difference
between
current
liabilities
and current
assets and
known as
*'net
working
capital'.
* Current
Assets:
Debtors,
Cash and
Stock
less Current
Liabilities:
Creditors,
Loans and
Tax = Net
Working
Capital
The
importance
of having
working
capital is
best
understood
as 'costs
expended
before
payment
received for
goods/service
provided to
the
customer'.
Therefore,
no capital
means no
produce and
no
customers,
which means
no
capital...
Working
capital has
three
categories
to balance:
Stock
Costing
Raw
materials,
work in
progress (WIP)
, finished
stock and
'bought in'
items are
valued at
the 'lower
of cost or
net
realizable
value':
basically,
only the
cost of the
raw
materials
can be added
to current
assets.
You should not
maintain more than two weeks stock if
deliveries can be made weekly, and the cost
of delivery is not chargeable to you.
Debtors
The total amount due to you by customers
that you have supplied credit to.
This figure
should not exceed 15% of your annual
turnover.
Cash
All cash in hand or at the bank that is
'available' for you to use.
The amount of working capital in a business
is an important factor when assessing risk
(i.e. credit assessment). The ratio, known
as the 'current ratio', is Current Assets
divided by Current Liabilities and is used
to assess the ability of the business to
meet current/short term liabilities: this
means has the company enough cash and stock
to pay immediate suppliers, bills and staff
wages. A ratio known as a 'quick ratio'
excludes stock and is a simple question of
cash, or lack of it!
Current Ratio
Current Assets (say) £900,000 divided
by Current Liabilities (say) £600,000 = a
Current Ratio of 1.5
A 'current ratio' between 1.0 and 1.5 is
average: less than 1.0 is a risk: over 1.5
is not a risk. However, this is only one
ratio, many
ratios are used to assess a business
risk.
Getting the Timing Right
Working capital is all about timing: cash
flow timing. Get it wrong and suppliers
withhold deliveries, staff cannot be paid
and sales dry up as you cannot produce your
services. There are a number of steps you
can take to ensure sufficient cash flow at
crucial times.
Work out how much cash you need from the
period the raw material is delivered to your
customer paying you.
a. Lead Time = 80 Days
b. Raw material delivered Day 0
c. Goods produced at Day 20
d. Goods finished (waiting delivery to
customer) Day 25
e. Supplier paid Day 30
f. Customer invoice paid Day 80
g. Period of self financing 50 Days (e - f)
This means you must have enough cash in the
first instance to fund your business for 50
days. To calculate how much you need, divide
your annual turnover (projected figure or
last years) by 365, then multiply the figure
by 50 to get the 'rough' figure you need in
cash (working capital). An example:
Turnover £500,000 Divided by 365 = £1,370 x
50 = £68,500 required to finance lead time.
A further precaution is to ensure low stock
levels at all times. increase 'c.' (above,
Goods produced) by 20 days and the above
£68,500 suddenly becomes £95,900!
(frightening).
Also, odd as it at seems at first, you
should keep working capital at a minimum
level. A high level of working capital means
high debtor and stock levels: debtor levels
should run at about 15% of turnover, and
stock levels at about 1 to 2 weeks
production (depending on industry of
course). Your cash should be paying off
loans, upgrading machinery or invested in
training and new premises: make the cash
work. High debtor levels and a bank
overdraft spell insolvency.
Use a
cashflow forecast and
statement to control your working
capital up to 12 months in advance. This
will allow you to estimate utility,
building, staff and expense costs with a
high-degree of accuracy.
Breakeven
Within the cash flow forecast you need a
breakeven sales figure to target as a
'must do' scenario. The definition of
breakeven: "The level of sales (by volume or
selling price) at which sales equal costs
(no profit, but no loss either)." This means
that if your total costs for running your
business for, say, one month was £5000 and
you sold carpets at £1000each: you would
need to sell '5' carpets, or put another
way, £5000 worth of carpets.
Too Many Sales!
The paradox of 'overtrading'
is mostly about working capital. Getting the
'big sale' that doubles your turnover has
been the downfall of many successful
businesses. Using the above equation in
'Getting the Timing Right', the period of
self financing is unchanged, however the
daily amount required to fund your business
will ensure you run out of cash half-way
through the lead time. This means your
suppliers stop deliveries (as they cannot
buy raw materials) and your new big customer
starts cancelling orders and withholds
payment to you, you ignore your smaller
customers to fulfill the order: an order
that is loosing profitability at lightning
speed...
The Way It Should Be - the 'Working
Cycle'
You put capital (cash) into your business...
...You purchase raw materials
You pay suppliers
You pay staff costs
You deliver service/goods
You allow a credit period
You raise an invoice
You receive money
You purchase raw materials...
Pre-fixing each
stage with 'You' is to ensure that you see,
quite easily, the dependence of working
capital upon your actions and not your
suppliers or customers actions. You must
work to maintain a strict regime within your
business that will allow for emergencies,
but not for poor financial management from
any key area within your working cycle. If
your customers do not pay you as agreed let
them know that you cannot allow such action
within your financial system, and that if
they default again you will have to consider
supplying alternative customers (wouldn't
that be nice!).
THIS
WEEKS TOPIC 2
New Rights for Part-time Workers Including
Homeworkers
The European Union has drawn up new rules
about Part Time Work in order to protect the
rights of part time staff and to encourage
more flexible ways of working. On 3 May the
UK government announced they would implement
these regulations subject to parliamentary
approval. Businesses have 8 weeks to prepare
for the regulations before they come into
force on 1 July 2000.
What does this
mean to the worker?
In a nutshell
these new regulations will ensure that
part-timers will no longer be treated less
favourably than full-timers with:
- comparable
rates of pay
- overtime pay
if they should work more than normal
full-time hours
- pro rata sick
and maternity pay
- access to
occupational pensions
- access to
training
What sort of
workers will have these rights?
Anyone who is
employed by an employer on a part time basis
including those who are employed to work at
home and who can compare their work to a
full time worker in the same company. The
emphasis on this legislation is to make sure
part time workers are not treated less
fairly than full time workers.
However, the
main thrust of this legislation is to
encourage people to look at more flexible
ways of working so that if you wanted to
reduce your hours of work, and your employer
agrees, then you would continue to be
entitled to the benefits and rates of pay
you would expect as a full-timer but on a
pro-rata basis.
What does this
mean to the small-business employer?
Small businesses
will not be exempt from implementing these
regulations, so there may be the cost
implications for providing the above.
Businesses have 8 weeks in which to prepare
for the regulations. If an employee should
want to make a complaint about unfair
treatment then the employer now has 21 days
(formerly 14 days) in which to submit an
answer. The regulations are available at
dti.gov.uk
Comment
These
regulations are to be applauded because they
acknowledge the equal rights of part time
workers including those that work at home.
They also encourage people to consider more
flexible ways of working because they know
they will have the security of certain
rights. Women returning to work may be the
main beneficiaries. However, there are
plenty of loopholes for employers to avoid
extra costs, and workers will find they may
have extra hurdles to jump through for these
regulations to be enforced. As with most
government proposals I would say that there
is more hot air to these regulations than
actual financial benefits. But the warm glow
from that hot air will provide a welcome
psychological cushion and may help to
positively change attitudes to flexible ways
of working.
© Caroline
Tresman, Editor of 'The'
Homeworking Web Site
THIS
WEEKS TOPIC
3
Communicating at Networking Events by Alan
Bird
For most of us there is no avoiding the
networking circuit: be that through
networking clubs, business associations,
exhibitions or conferences. The initial
scenario: your new business, possibly new
product (makes no difference to the stress
level if you were selling the oldest
business in the world, whatever that is:),
and you being new to running a business, is
sure to make you feel like you are the only
person in the room wearing a pink bikini,
with a sign on your back saying 'it's my
first time, treat me nice'.
There are certain groups that attend
networking events:
a. The Newbie
Stands alone, smiles at everything that
moves and constantly goes to the bar, the
toilet, the coffee machine, the buffet
table, the car park, in fact anywhere that
avoids actually talking to anyone. Wants to
appear busy without doing anything
confrontational. Believes that one-day they
will be accepted, if only because everyone
will know their face.
b. The Amateur
Hovers anywhere, takes unhealthy interest in
your business, has the bodily consistency of
chewing gum, has an out of this world
business vision, and product. Uses stealth
limiting radar to find you at next meeting.
c. The Pro
Been networking since the 80's, they know
most newbie's work for nothing. They get
close to other networkers and milk the life
out of their contacts and friends etc. Are
they good or bad? - bit of both, probably.
d. The Networker
Stands in a group, with one eye always
watching what goes on around them. Motto for
every networking session 'come away with at
least one more contact'. Usually has a
successful business, and enjoys being at
networking events for the buzz, and of
course, the opportunities. This person will
look after the newbie, introductions will
follow and will also offer a bit of
mentoring (as they probably do all day long
in their own business).
It has long been the issue of how to
approach fellow networkers at an event: with
justifiable reason. Some events have lost
the principal objective: meeting new
business opportunities. Quite literally, the
tighter the group at an event, the harder it
is to get yourself in. If you see a group of
networkers talking and there is a reasonable
space between them, there is a reasonable
chance of joining that discussion.
Those who network do so because they want to
be there, they want new business, they want
to meet new contacts and they understand the
initial pressures of joining a group. With
this in mind you should approach one of the
key organizers and ask for their help in
pointing out possible sources of business,
or one better, get them to introduce you to
them: organizers are there for this purpose
(or they should be).
Your responsibility, when introduced, is to
say something interesting about something
you know both of you have an interest in:
i.e. if you sell marketing/advertising and
the target has a printing business, you
would say something like, "have you seen the
latest calendar sent out by The Print
Shop?". You would then be able to both talk
about the same thing and get a feel for each
other: remember this is not a sales pitch,
it's just common ground. You might end your
conversation by offering to send them the
calendar, or bring it with you next time,
even offer to bring it to them at their
business premises when you 'next pass by'.
Experienced networkers love saying to
business contacts, "I know someone who can
do that for you, I'll have a word with them
and see what we can do": being able to say
this adds value to their own services, it's
the next best thing to getting the work
themselves (and you may pay them a 'finders
fee').
As with the Internet chat groups, keep your
initial comments limited and work your way
in over a number of events. That said, if
you have something really worthwhile to add,
go for it (just be sure). Never make
promises you cannot keep: it's easy to try
and please in this environment. No harm in
saying that you will try to do/get
something, but, failure sticks in the mind
longer than success.
Every difficult thing I do in life for the
first time extracts the same response from
within me: 'it won't be difficult soon'.
With networking, after a while you know most
people in the room and approaching a lone
newbie becomes an adventure: where will this
contact lead to!
