This article shows you 10 Ways Little Working Capital Can hurt Your Business.
- Missed business opportunities
Difficulty in meeting day -to- day expenses
- You cannot make bulk purchases
- Difficulty in paying creditors
- Lost trade and cash discounts
- Inability to get loans from banks
- Good employees will leave
- Good customers will leave too
- Your business cannot grow
- Suggested Solutions
Working capital may be defined as the difference between current assets and current liabilities.
Put differently, when current assets are more current liabilities, you will get positive working capital balance.
On the other hand, if liabilities are more more than current assets, you will get negative working capital balance. Nng
When you have persistent negative working capital balances, your business will always run short of cash.
Negative working capital is a dangerous zone you should not allow your business to go into.
Current Assets vs Current liabilities
On one hand, current assets include, among others:
- cash and cash equivalents
- short term investments
- Cash at bank
- and others
On the other hand, current liabilities are payments you are expected to make within the next 12 months.
They include, among others:
- accrued wages
- Unpaid business expense
- Bank loans and overdraft
- Taxes not yet paid
- and others.
Thus, working capital is equal to Current Assets minus Current Liabilities.
Let us now look at the impacts of little working capital on a business.
1. Missed business opportunities
One of the consequences of little working capital is that you can miss some good business opportunities.
For example, if you have little working capital, you cannot take advantage of clearance sales which companies do.
Example can be seasonal sales before Christmas and new year.
Consequently, your competitors can easily make use of such opportunities.
The effect of this on your business is that you cannot compete in the marketplace.
When you are not able to compete, your competitors can easily kick you out of business.
This can happen because your selling prices will be higher than those of your competitors.
Most importantly, you should remember that customers are always moving around looking for better deals.
2. Little working capital: Emergency Expenses
Little Working Capital can impact your ability to meet the regular running costs of your business.
For example, sometimes business expenses not captured in your can just pop up.
An example can be when the community where you do business imposes a levy on businesses in that area.
Clearly, you cannot run away from such levy.
If you are unable to pay, it can cause you and your customers some embarrassments.
3.You cannot make bulk purchases
Another consequence of little working on your business is that you cannot make large purchases of stocks and inventory.
Consequently, you will find yourself buying from middleman instead of buying from manufacturers or importers.
And as you are not buying from cheap sources you cannot sell at competitive prices.
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 will drop because consumers will continue to exit. Your business cannot grow.
Obviously, that is not what you want.
4. Difficulty in paying creditors
Little 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 lenders are not willing to give you credit facilities, your option will be to approach family and friends for financial assistance.
5. Little working capital: Missed trade and cash discounts
Insufficient Working Capital can make you miss trade discounts.
Some companies do give their big customers trade discounts to encourage them to buy more.
Beyond that, it is another way of showing customers that they appreciate their business.
Furthermore, trade discounts are intended to make it easier for you to sell their products at competitive prices.
Similarly, some companies also grant cash discounts to customers who pay their bills before the agreed time.
Do not forget that cash and trade discounts already form part of your profits , even when you have not yet sold!
Therefore, to enjoy these incentives, you must show that you are someone they can trust.
And that you are ready and willing to establish a long term business relationship with them.
6. Working capital management: Inability to obtain loans
When you have little working capital the bank is one last resort you can call for credit.
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 data obtained from your financial statements to determine whether or not they can do business with you.
7. Good Employees can leave
Another side effect of poor working capital management 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 afraid that one day you can ask them to go.
Furthermore, they can leave if they have no:
- 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 the future.
8. Little working capital: Customers will Leave
Another top side effects of Insufficient working capital is that your good customers can leave.
In other words, they will 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.
Remember that customers do not like stock outs.
Stock outs waste customers’ time and even cost them more money.
Therefore, to retain the loyalty of your customers and acquire new customers, you must maintain you must maintain a healthy
9. Your business cannot grow
Too little working capital can stunt the growth of your business.
The reason is that you will not be able to cover the total costs of running your business.
In other words. when your expenses are greater than your revenue, it will be difficult for your business to break even.
Your business will break even if your revenue is equal to your business expenses.
Remember that it is only when your business is able to break even that you can talk about profits.
Most of the importantly you should know your business can break even only when your revenue is equal to fixed costs and variable costs.
At break even point of you business is neither making profits or losses.
10. Working capital management: Inability to Attract Investors
Insufficient working capital can make it difficult for your business to attract investors.
Your working capital balance will disclose to investors whether it will be worthwhile to invest in your business.
How to Improve Working Capital
If your business is struggling to maintain a positive working capital, you must take steps to improve the situation in order to remain in business.
The following are some of the ways you can improve your working capital:
- Focus on receiving cash payments in advance
- Ask for cash payment for every sale closed
- 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 increase your working capital
- Allocate a reasonable fraction 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
It is not possible that you know everything.
When you get stuck any where along the line, ask questions and get answers.
You should also feel free to seek advice from financial consultants.
Parting with a few dollars to get helpful advice may not be a bad idea.
Finally, you should not be shy to seek advice from your mentor or other people who have been there before you.
By Samuel Ijenhi, B. Sc. Accounting
University of Benin, Benin City, Nigeria.
Founder: Ijenhi Business Solutions