Working capital is simply the value of “liquid” assets available on any day of the week to be able to pay your current bills. This consists generally of cash, accounts receivables and inventory. It will not take a rocket scientist to realize that if you do not have enough cash on hand to make all your necessary payments then you have to collect the monies due to you and you must convert your inventory into cash sales.
As a business owner you therefore have to be a cash manager a bill collector and a creative genius for converting inventory into profits. The value of sales has to be more than what you paid for the inventory and for what it costs to convert it to the finished product. You have to have a profit margin that is sufficient to sustain payment of your daily expenses.
Profits when re-invested back into the business (meaning not all stripped out by the business owner) allow for your business cycle to continue; i.e. new inventory purchases. But often in a struggling start-up operation I have seen entrepreneurs blinded by the need to add equipment they may feel is necessary for growth. Prior to engaging in this practice however the entrepreneur should make sure that the expenditure will not jeopardize his/her ability to maintain supplier payments. “Don’t fall in love with assets” If they do not produce a profit for you then do not buy.
I have seen many cases where new business start-ups fall into the trap of over spending on capital assets before they become profitable, always thinking that more sales will be “automatic” once the new equipment is installed. Think again! Ask yourself this; “If my sales do not improve how am I going to continue my bill payments?” Before spending valuable working capital make sure you have performed a proper cost benefit analysis, do not go with your “gut feel”. Prove to yourself in research and numbers that your acquisition will be a net benefit to your business.
Once you spend your working capital the only way to get it back is through greater sales and maintenance of proper profit margins. If there is doubt about this don’t spend!