If Cash is King, Working Capital is God.

The biggest single use of the cash provided by a growing company’s profits is growth itself, because goods sold on open accounts require an outlay of cash well before cash is received from the sale of the goods. This is especially true in businesses that sell out of an inventory of goods, but applies in the sales of services as well.

Simply explained with an example, if a business holds inventory for an average of 82 days, takes an average of 36 days to collect accounts receivable and pays its accounts payable in an average of 28 days, the business will have a cash conversion cycle of 90 days (82 + 36 – 28). Ideally the carrying cost of the cash conversion cycle is included in the sales price of products, but what does this mean to this company that is going to grow from $10 million in sales to $14 million in sales this year (with a 35-percent gross profit and 10-percent selling, general and administrative expenses while increasing inventory by only 20 percent)? The company will require a cash injection of more than $779,000 to finance the cash conversion cycle, while the CEO or business owner may be naively expecting to have $400,000 more in cash from profits. The swing between perception and reality can be quite shocking, especially when the available credit line going into the year is, for instance, $200,000.

This does not mean growth is bad. It does mean it must be carefully forecasted and managed. The biggest step is finally recognizing that growth requires a lot of cash.

Link to the full article written by Dennis Niven here: IFCashIsKing

Zach Miller helps businesses of all sizes understand their true financing needs. Have questions about cash flow planning? Contact Zach at [email protected]