Here’s an anecdote. An early-stage start-up had a groundbreaking product. They had created a proprietary mechanism that made your phone diagnostic equipment. And through your phones, you could measure your diabetes and blood pressure. The media lapped it up, and so did the investors. Indeed a revolutionary product of its time. Fourteen months down the line, the same press reports the story, that this start-up has shut shop, and the founder has taken up a job elsewhere.
What exactly happened? Did the software not work? Did Amazon acquire the business? Issues with the investors? None of it happened. The founder had to shut shop because of a poor understanding of business finance and to burn up working capital. These stories are choc-a-bloc in the start-up sector as well as the MSME Sector. The SME Working capital truly is the silent but deadly killer that sometimes floats the company and sometimes sinks it.
Before understanding how does the working capital do it, let us try, and understand what is working capital?
Working capital is broadly defined as capital of the business which is utilised in the day-to-day workings of the company. It can be used to facilitate something simple, like paying internet bills to something significant like paying off a vendor.
Mathematically put, it is calculated by subtraction of net current liabilities from the net existing assets. Smooth management of working capital is an essential aspect of business finance. It allows organisations to achieve their short-term goal and operational expenses. The short or current, in both cases, can be defined as 12 months generally, and if the organisation is leaner, it can find its definition ranging from 6 months to 12 months.
The current liabilities are paying operational expenses, salaries, vendors, and taxes. The current assets include the amount due from the customers to whom the company has provided their materials or services, the inventory of the company, and the amount of the cash available with the company.
The most obvious and yet the most important thing about working capital, the cardinal rule of SME Working Capital is, it should always be in the positive. The ratio between assets and liability should be +1. There are various components to working capital management and improve the business finance practices to increase the SME Working Capital, which is one of the vital forces enabling scaling up.
- Accounts Receivable: Accounts receivables is the amount that is due for collection. It is the amount companies need to collect in lieu of their services or products offered. They are potential assets, but they can’t be considered assets until they are deposited in the company’s bank accounts. Days Sales Outstanding is a well-known parameter used by industry experts to gauge if the company collects the receivable amount in optimal time.
- Accounts Payable: In layman’s terms, this is the monies the organisation owes to its people, be it vendors or collaborators. It essentially is a liability. To maintain a positive ratio, the company delays payments as much as possible. The days between accounts receivable and payable is a significant difference.
- Inventory: These are the company’s assets that can be converted into revenue. Any company’s success can be measured by how quickly it can sell its inventory and then recreate it. Inventory turnover rate is an indicator of sales performances.
Positive working capital also enables you to establish great rapport and build goodwill with your vendors as you can pay them off as early as possible. High working capital also allows a constant supply of raw material for manufacturing and thus, enabling a successful cycle of production to sales to profits. Therefore, ensuring smooth business operations. Positive working capital also allows the companies to overcome crisis.
In the SME sector, having a positive working capital is encouraged. To achieve this, working capital loans are also provided through various Working Capital Schemes. There are other loans for working capital which enable the company to pay off their vendors, buy new machinery, pay off salary, or anything that a growing company needs
At ZipLoan itself, we provide a gamut of loans, and among them, working capital loan is a teeny tiny aspect of various loan schemes. These loans can be availed within three days, with minimum paperwork, no collateral at all, and no hidden charges.
If you’re an entrepreneur and reading this, understand, if your business is a human being, working capital is oxygen, as the human can’t exist without oxygen, the business cannot exist without working capital.