Ready for Good Times?

Additional Business Requires Additional Working Capital

 

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Is Your Business Ready for Good Times?

 Is your business ready for good times? 

 As I'm writing this, there are signs the economy is coming out of the recession.  For many businesses, the improving economy is like a breath of fresh air.  After several years of challenged revenue, profitability and cash flow, it seems like there is light at the end of the tunnel.  So what could possibly go wrong?

 Well there are three things I can think of right away.  They are:

  • The economy might not recover after all.
  • Businesses might get ahead of themselves, catching up on deferred investments with the expectation that business will be better.
  • Business picks up dramatically causing cash flow issues with businesses whose sales are suddenly booming.

 It's this last point I'd like to discuss in this article.  For businesses that sell from inventory and get paid on terms, there is a cash flow gap between the time the inventory is paid for and the when they receive cash from their customers.  If sales increase dramatically, the business will require adequate cash to cover the additional inventory until they receive cash from customers.

 Let's take a look at what this might look like.

A business sells $50,000 per month at a 50% gross margin.  Suddenly the business is selling $75,000 per month.  To have inventory to adequately fulfill the additional $25,000 per month in sales, the business would have to increase its inventory by around $12,500, assuming the business keeps a 30 day supply of inventory on hand.  If the business takes 30 days to pay its accounts payable and it takes 30 days to collect their accounts receivable, there would need to be an additional $12,500 investment in the business for at least 30 days without additional cash flow.  Does the business have access to the additional capital?

I understand that in real life, nothing is this simple and there are a lot of moving parts not covered in the above scenario, but I suspect you see my point.  If your business grows, you will likely need to invest in it in some way to meet the additional demand for your goods or services.  Things like additional inventory, additional marketing, or additional employees such as sales staff, customer service or people to deliver the services your provide.  Is your business ready for good times?

For a downloadable Word document of this article, click here.