Talking Cents

A tip from a Sydney small business accountant - working capital is key

Chances are that if you’ve come across this blog you are a small business owner, or at least thinking about becoming one. Many business coaches and accountants who like to create complexity and in turn confusion for small business owners will give you all sorts of advice on how to run your small business and what you should be measuring.

Now, as small business accountants who service our clients in both Sydney and Melbourne, I’m sure that in an ideal world we’d all like to know every key metric of your small business at any point in time but reality tells us that this is simply not possible and even if it were possible, it would be overkill for the time-poor small business owner.

So today, from a small business accounting perspective, we’re going to break down one simple, easy to measure and critical yardstick for your small business, namely, working capital.

Working capital in its most basic form consists of answering the question, “How much real money do you need to fund your daily operations?” Knowing how much working capital you need is a little more complicated and largely depends on your type of small business. An IT contractor with few expenses requires little working capital to survive, whereas a retail business requires extra funds in order to be able to pay for and carry stock on the shelves before it’s been sold.

Working capital is broken down into the following four categories:

1. Cash. Yes, as simple as it sounds, no small business survives for long without cash in the bank and keeping an adequate amount allows you to pay your bills and staff on time, take steps to always keep a minimum cash reserve on hand.

2. Debtors. Money owed to you by clients is a short-term asset that will be turned into cash within your normal payment terms. The better you are at monitoring and tracking your debtors, the more cash you have in the bank. The longer debtors are allowed to go unpaid, the harder they get to receive. Plan to chase up debtors on a regular basis and don’t be afraid to lose clients who don’t pay on time. Your resources are better spent on clients who pay on time and don’t burden your working capital and in turn create pressures on the rest of your business.

3. Inventory. Small businesses that are required to maintain a level of stock in their business are particularly susceptible to working capital issues. Running with too much stock, for that just in case scenario, should no longer be necessary. Know your business and its seasonal variances and plan accordingly. Obsolete stock on the shelves needs to be eliminated and turned into cash, think outside the square on ways to sell it off, even if it’s only at cost. Leaving it on the shelf for too long will actually cost you money in lost opportunities.

4. Creditors. Make sure you keep on top of your creditors as often as you chase your debtors. By knowing exactly what you owe you can plan ahead and keep in contact with your suppliers to keep them on side. A bad relationship with a key supplier over late or unpaid invoices can affect your ability to access discounts or new products.

Keeping a close watch on these four factors will go a long way towards building a successful, healthy business with the ability to seize opportunities as they arise, rather than being restrained by your bank account and cash flow constraints.

For more great tips on keeping a watch over your small business, contact mas accountants, the original accounting office for small business, in either our Sydney or new Melbourne office.