Consequences Of Inadequate Working Capital
There are many consequences of inadequate working capital.
Inadequate Working capital means that your current assets are slightly above or equal to your current liabilities.
This means that you you will be able to meet the day to day expenses of running your business.
Inadequate working capital can affect your business in many ways.
It usually also has severe consequences on your cash flow.
Let us now look at how inadequate working capital can impact on your business.
Missed business opportunities
One of the consequences of little working capital is that you can miss some profitable business opportunities.
For example, if you have no working capital, you cannot take advantage of seasonal clearance sales which some companies sometimes do.
An example of such opportunities can be clearance sales before Christmas and the new year celebration.
When you have no working capital, your competitors who have no issues with working capital can easily good hase products at cheap, sell them and make good profits.
Consequently, when you are not able to compete, your competitors can easily kick you out of business.
Most importantly, you should remember that customers are always moving around looking for better deals. They can be very slippery.
The greatest ways to hold them is provide quality products at competitive prices.
Therefore, failing to do that your customers will leave you.
Inadequate Working Capital : Emergency Expenses
Insufficient working capital can make it difficult for you to meet unexpected business expenses.
For example, sometimes some business expenses that are not captured in your cash flow or budget can just pop up.
An example can be when the community where you do business imposes a levy on all businesses in that area.
Clearly, you cannot run away from such levy.
If you are unable to pay, it can cause you some embarrassments.
In extreme cases, the impact of such embarrassments can spill over to your customers.
You cannot make bulk purchases
Another consequence of little working capital on your business is that you cannot make large purchases of stocks and inventory.
Consequently, you will find yourself buying stocks in little quantities from middleman instead of buying directly from manufacturers or importers.
The first consequence of this is that your selling prices will be higher than the prices your competitors are selling.
Secondly, your sales and profits can begin to reduce because consumers will continue to exit.
Therefore, your ability to continually make bulk purchases is dependent on the size of your working capital.
Difficulty in paying creditors
Insufficient working capital can make it difficult for you to pay your creditors and suppliers within the agreed time.
The consequences can be serious because:
- Suppliers will not trust you any more
- Your credit rating will drop
- Suppliers will insist that you pay cash for every single item of stock you buy.
Furthermore, banks and other business partners will be unwilling to do business with you.
When this happens, the only option available to you is to approach your family and friends for financial assistance.
Ask them for non interest bearing loans. But make sure that will pay back the loan, if they give you.
Lack of working: Missed trade discounts
You can miss trade discounts if you have no working capital.
Some companies can give you trade discounts to encourage you to buy more of their products.
It is another way of showing you that they appreciate your patronage.
Another reason why they can give you trade discounts is that they want to make it easier and quicker for you to sell their products so that you can come and buy again from them again.
However, remember that you have to earn this incentive by being a loyal and reliable customer to them.
Similarly, a company can give cash discounts if you are able to pay your bills before the agreed date.
Again, this incentive is intended to encourage you to pay your bills before due date.
Beyond that, the company can do this for you because they too want cash to improve their cash flow.
Do not forget that cash and trade discounts can already form part of your profits , even when you have not yet sold!
Therefore, to enjoy this incentive, you must show that you are someone they can trust and rely on.
And that you are ready and willing to establish a long term business relationship with them.
Lack of working capital: Inability to obtain loans
When you have no working capital, financial institutions will not be interested in funding your business.
This is because, banks are usually not interested in funding businesses that have liquidity problems.
For example, when the bank is considering your application for funding, they will look at some metrics such as:
- Fixed assets,
- Current assets
- Current liabilities
- Working capital balance
- The earning capacity of your business,
- Cash flow
- Growth history
- Your debt profile
- Even your personal profile
- And so on.
The bank will, therefore, use the stats obtained from your financial statements to determine whether or not they can do business with you.
Therefore, without working capital you not qualify for funding by a bank.
Good Employees can leave
Another side effect of poor working capital is that some of your good employees can leave.
They will want to leave if they observe that customers are only coming in few numbers.
In other words, they will become apprehensive that one day you can ask them to go.
Furthermore, they will want to leave if they are not sure of:
- Job security
- Regular payment of salaries
- Job satisfaction
- No prospects for career development
Employees need regular salaries to meet their needs, support their families and to plan for their future.
Therefore, do not allow lack of working capital to make you miss the best brains in your business.
Lack of working capital: Customers will Leave
Another top side effect of lack of working capital is that your good customers can leave.
In other words, they can take their businesses to your competitor next door.
For example, if your customers begin to experience stock outs whenever they come to your shop, they will move to where they can possibly get all their needs in one place.
Stock outs waste customers’ time and even cost them more money because they will still need to move from store to store looking for their needs.
Therefore, to continue to enjoy the loyalty of your customers and acquire new customers, you must maintain a healthy working capital balance.
Your business cannot grow
Lack of working capital can stand in the way of your business growth.
The reason is that you will not be able to cover your operating expenses.
In other words. you can only talk of profits after you able to cover your operating expenses.
Therefore, you can see that business growth is predicated on profits.
Lack of working capital: Inability to Attract Investors
Insufficient working capital can make it difficult for your business to attract investors.
For example, your working capital balance will disclose to investors whether it will be worthwhile for them to invest in your business.
Therefore, to get them to invest in your business, you need to demonstrate to investors that you have all it takes to make your business profitable.
How to Improve Working Capital
If your business is struggling to maintain a positive working capital, you must take the following steps to improve the situation in order to remain in business.
- Focus on receiving cash payments in advance
- Ask for cash payment for every sale close
- Constantly review your accounts receivable
- Encourage customers to pay early and, possibly, give them some discounts
The following recommendations might help you to reduce the effects of insufficient working capital:
- Sell off any assets that your business has not used in the last six months.
- Use the money realized from such sales to beef up your working capital
- Allocate a reasonable portion of your capital to current assets
- Avoid expenses that do no add value to your business
- You should learn how to manage money
- Sell to customers on cash and carry basis.
- Collect your money from debtors
- Increase Revenue and reduce expenses
- Buy only fast selling products
- Upgrade your customer service
- Do more advertising and sales promotions
- Treat your workers well
- Also treat your employees well
- Network with other businesses in the same industry with you
- Ask family, friends and associates for short term soft loans
When you get stuck any where along the line, you should feel free to ask questions from people who have been there before you; your mentors, financial advisors and older business men.
Parting with a few dollars to get helpful advice may not be a bad idea.
By Samuel Ijenhi, B. Sc. Accounting
University of Benin, Benin City, Nigeria.
Founder: Ijenhi Business Solutions