Last updated on February 28th, 2021 at 06:42 am
Cash is King. But you don’t realise it until you’re short of it, and insufficient liquidity is why most companies go bust. Vendors will only be patient for so long before they pull the plug and you suddenly find you don’t have a screw for the car, which means - you can’t sell the car. A recent review by the America Small Business website shows that 82% of companies fail because of poor cash management.
Any company, big or small, can have large assets on their balance sheet but unless those are current assets, converting them to cash is extremely difficult. Working capital allows companies to handle the regular expenses on a day to day basis.
The working capital cycle (WCC) is the process of using cash to buy raw materials that you make into the finished product that you then sell for cash to buy more raw material...so on and so forth. There are two key questions here. Where do you get the initial cash to buy the raw materials?
What do you do while you wait to sell the finished inventory? It is, of course, the proverbial chicken and egg situation.
Since you’re not the only one in this situation, the global economy has it figured out for you. In general industry, norms will bend time just enough for you to pay for your raw materials once your finished goods have sold. So what that means is that your Accounts Receivables days outstanding (the moment from you sell your product to when you get paid for it) has to be significantly less than the Accounts Payable days (the grace time your suppliers offer you- often 30 days).
This situation allows for a good working capital cycle. Alas, business is rarely that easy. More often than not your vendors want their payments faster than your customers can pay.
Murphy’s law. Managing this cycle is what sets companies apart. It’s why retail is such a favoured game because retail is a cash-centric business. A company like Zara might pay its suppliers (raw material, outsourced vendors) within sixty days, but you have to pay for that crop top right away!
