Did you know a colossal 82% of small businesses that fail can chalk it up to one reason? That reason is a cash flow problem.
Getting started with the right amount of capital is crucial to making sure your business doesn’t run into this all too common problem.
Let’s take a look at the ways you can breakdown how much working capital your small business needs.
Defining Working Capital
Working capital is essentially the difference between your business’s current assets, what can be turned in to cash in the next 12 months, and your current liabilities, or the costs and expenses your company will sustain within the same period.
To accurately determine the amount of working capital a small business needs, it’s important to define these three factors:
- The Type of Industry You’re In
- Operational cycle
- Business Growth Goals
The Type of Industry You’re In
Depending on the type of business you run, you may require a higher working capital amount than others.
Those in the retail sector are a perfect example of this challenge. These types of businesses can be seasonal, so there are times during the year when an influx in capital is needed. This capital goes towards day to day operations, such as hiring additional staff or purchasing extra equipment and inventory to meet an increase in demand.
Other businesses, such as a consultant or web hosting service, may not require as much to cover expenses because their products aren’t tangible goods and their overhead is likely to be more constant.
Timing is an important element that you can easily overlook when trying to set up a good cash flow management system.
Creating this system is where your operational cycle comes in.
Included in your operational cycle are three types of “days” you’ll want to monitor:
- Collection days where you measure how long it takes to collect on accounts.
- Inventory days or how long it takes to turn your product or services into cash.
- Payment days or how long it takes you to pay a bill.
This cycle will give you a good idea of when and how your assets and liabilities stack up within a 12-month timeline.
Business Growth Goals
Where do you see your business in five years?
If you’re looking to scale up your small business or venture into a new market, the amount of capital needed will increase. Factors, such as market research, expanding inventories, and adding additional employees, can quickly balloon your business expenses.
You and your business can prepare for success and achieve sustainable growth using an analysis of past capital needs as well as anticipated growth needs.
Sustainable growth always includes a bit of forecasting. You want to include forecasting as part of your long-term growth strategy. This process helps you identify where you may need to tighten up on expenses or add more sales volume to ensure your finances stay balanced.
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