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Selling yourself into bankruptcy

Over the years many companies have come to me requesting funding to cover financial shortfalls because they did not properly plan for their working capital needs. The amount of working capital you need changes as your business grows and is often seasonal if your business is seasonal. As your business grows your working capital needs grow also! 

A business that does not have a working capital plan can literally sell themselves into bankruptcy. As sales increase the cost of working capital increases and because they have not properly planned for this the business has to take high interest loans and cash advances which ultimately kill the cash flow and therefore the working capital is not there.  

 

Working capital is part of what it takes to operate the company and therefore is not considered as income or cash; this especially important when selling your business or seeking investment capital or business loans. The buyer, investor or lender will have to paid out of the cash! Many entrepreneurs who have pitched me on investing in their business have made the mistake of not separating the working capital and therefore promise returns based on the income minus the expenses while not figuring in the working capital float. The working capital float is the what a business uses to cover expenses while they wait to get paid. 

You may not think you have a working capital float but every business does. Some example of things that the working capital float covers are: office rent, inventory, advertising, payroll, utilities.
 
Working capital is an asset owned by the company and is a measure of the a company’s financial strength and liquidity. Working capital is often used to measure the value of a company.
The simple formula is: Working Capital = Current Assets – Current Liabilities
This simple formula works for small businesses but most companies use the Adjusted working capital formula.
The adjusted working capital formula is: Adjusted Working Capital = Accounts Receivable + Inventory – Accounts Payable – Accrued Operating Liabilities
Both formulas use balance sheet values, but the simple formula may or may not include cash as an asset where the adjusted working capital formula does not include cash at all. The nuances aren’t always critical when running a successful business, but can be extremely important in calculating a companies value.
Robert Ritch

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