Working capital is the capital of a business, which is used in it’s day-to-day trading operations, calculated as the current assets minus the current liabilities. Current assets are held for a short period of time and will be converted into cash within one year e.g. trade debtors, prepayments, stock etc. Current liabilities are short term obligations and are debts due to outside parties within one year e.g. trade creditors, VAT, PAYE, leases and loans.
If current assets exceed current liabilities, you have “positive” working capital. That’s a good sign and suggests that you have sufficient resources to fulfil short-term obligations. However, a negative number indicates the business might struggle to cover liabilities and could end up in a cash flow deficit. Family businesses need to balance the short-term financial needs with long-term goals. That is, meeting current financial obligations but still planning for the future and having enough resources to fund sustainable growth.
What is Working Capital Management?
Working Capital Management refers to a businesses managerial accounting strategy designed to monitor and utilise the two components of working capital; current assets and current liabilities, to ensure the most financially efficient operation of the business. Family businesses often rely on financial support from family members, meaning that personal finances and business finances can become linked, however, it is important for both the business and the owners to be financially independent. Managing working capital effectively can help a family business grow and ensure there is a legacy to be passed on to the next generation, which should in turn provide peace of mind and reduce financial stress.
Understanding Working Capital
To manage your working capital, you need to understand it. Sometimes clients ask us, “Are you sure I made a profit? I have less money now than I had at the start of the year.” You can be showing a good profit on the books and still be strapped for cash to cover immediate debt. A business’ ability to generate cash is crucial, and businesses with low cash reserves or unstable cash flows can be vulnerable.
Cash might be King, but Working Capital is Queen. Businesses with strong working capital are proven to be less impacted and more resilient during challenging economic times. The changes announced in the Autumn budget 2024 are an example of how businesses need to be agile. Managing your working capital effectively is a practical and cost-effective way to fund growth and the businesses profitability. In terms of family businesses and a need to understand working capital, funding succession is a significant challenge faced by family business owners. To ensure there is wealth there to succeed, family businesses need to ensure that they are allocating their resources efficiently, making sufficient investment in growth opportunities, all whilst maintaining adequate liquidity. This challenge will only be overcome if owner-managed businesses understand the working capital requirements of the business and can make informed decisions.
There are several factors that affect working capital needs and management. Internal factors are things such as your business size and desired growth rates; organisational structures; and your borrowing & investing positions. Externally there are several factors that are outside your control such as banking services, currency fluctuations, interest rates etc.
Strategies
Like everyday life, if we firstly focus on the things that we can control. Every business needs to have access to quality management information to make informed decisions. The Working Capital culture and processes for the organisation must be inherent and interwoven throughout the business’s entire operations, recognising that working capital problems are not just the domain of the finance department.
There are some practical strategies to improve working capital, such as managing your:
Customer/clients – businesses can accelerate monies due from debtors by following a few simple steps to try and reduce debtor days. These include practices such as agreeing payment terms in advance; establishing credit practices as a matter of company policy; and completing credit checks before onboarding.
Stock management – for better stock control you should carry out periodic physical stocktakes; know the number of times major stock items turn in a year; and consider selling off slow moving merchandise.
Work-in-progress management – There needs to be a focus on job management and converting work-in-progress.
Suppliers – some strategies to improve creditor management include tightly managed purchasing authorities; maximising credit terms, having alternative sources of supply; shopping around for best value for money; and passing on cost increases to your own customers quickly.
Overheads - If cost cutting, make sure the cuts are from the fat and not the muscle of the business. Cost cutting is essential within any working capital strategy, but do not impose arbitrary budget cuts, have a well-structured plan. Keep overheads under constant review, have the courage to discontinue some costs, if no longer consistent with the goals of the business.
Currency management - Simply allowing currency developments to take their course can seriously affect working capital and may mean, your business is selling at a loss. Hedging techniques are key and can range from matching receipts and payments to forward buying.
KPI’s – setting KPI’s specifically to measure and monitor various aspects of working capital in the business. It is important to review these and address any warning signs early.
Indeed, family businesses may have additional obstacles to overcome as family dynamics can sometimes lead to disagreements, especially around financial decisions. Businesses can help protect themselves from these challenges by implementing effective financial strategies.
In terms of management information, you shouldn’t always be “looking back” and you need to look forward. As part of this, cash flow forecasting is a vital tool for capital management, ensuring the financial stability and growth of the business as well as the well-being of family members. Cash flow forecasting enables you to plan for:
How much cash your business will need to keep trading
How much cash is needed to fund succession planning
When it will be needed
Applying for financing if there is going to be a shortfall
Managing excess funds
If your business is currently unable to honour its commitments, early action is key. Some potential things that you could do is:
Speak to creditors, Banks, HMRC/Revenue Commissioners
Explore options re deferring/restructuring debt
Regular communication with creditors
Reduce, defer or even consider cancelling drawings, dividends or other payments to shareholders or proprietors
Defer capital expenditure in the short term, or lease rather than buy equipment
Consider insolvency procedures
Depending on your business circumstances, there are also finance options that could be considered such as:
Sales credit insurance
Fee finance
Invoice discounting
Leasing
Asset-backed finance
Effective tax planning
VAT planning
If you find your business in a cash-surplus position, you still need to act. Knowing what to do with surplus cash could be vital, and you should consider:
Making more regular lodgments to your overdraft/loan facility (reducing interest bill).
Seeking better discount for early or cash payments to suppliers.
Capital expenditure may aid further business growth.
Examining short term investment opportunities.
Managing working capital is important for any business but particularly with family businesses, the Management Team need to have realistic short-term and long-term plans that suits their family needs, and ensure they are managing working capital effectively to fund these plans.
We at AAB regularly assist our clients, and indeed family businesses, in improving their management information, internal controls, succession planning, cash flow forecasting and applying for finance. If you think we could be of service contact them via the website here
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