Did you know that over-eating Christmas lunch can add up to well over 6,000 calories… at least you can work this off with a brisk walk (about 12 hours at 6mph!) But over-trading can be permanently disastrous for your business. Over-trading is where a business takes on too many orders, which despite being profitable, the business just hasn’t got the Working Capital to finance. What is working capital? Basically it’s the cash that should be in your bank account but at the moment it’s in someone else’s!
It’s the money tied up with your customers who haven’t paid yet (known as debtors) plus the money tied up in stock on the shelves of your business (that hasn’t been sold to customers) less what you owe your suppliers (creditors) because that cash is still in your bank account.
It’s a really important financial management concept to be totally comfortable with – you need to be aware and manage your working capital requirements. These requirements will grow as the business grows – it’s a problem that won’t go away and ironically the more successful you are the more working capital you will need.
At its simplest managing working capital is about three things:
1. Getting your customers to pay quicker
2. Ordering sensible amounts of stock
3. Negotiating favourable payment terms with suppliers…. easier said than done when you are a new business
Here are my top tips:
– When negotiating price, link it with payment terms as in “I will accept your proposal if you pay within X days or pay a deposit”
– Get deposits on order – it is not unusual in creative businesses to get 50% on order to cover materials
– If you are doing a big contract, break it down into stages and milestones, which trigger interim payments
– If you are working for big companies make sure you get a Purchase Order number. This confirms the work is authorised.
– With a new customer you are offering credit terms to, as well as doing background checks (useful site duedil.com) make sure you follow their invoicing procedures to the letter. And ring up and check they have the invoice and are happy with it.
– Can you include a subscription element to your business model? i.e. customers pay monthly for a regular delivery or service.
– This is not immediately obvious and a bit counter-intuitive because by ordering more you can get a better price… in the early days, my advice is to manage for cash rather than profitability so order smaller quantities. Yes you end up paying more but you reduce the amount of cash tied up. Plus you are less flexible if you have bought lots of stock.
– The key word here is negotiate. Just stringing your suppliers along is not sustainable in the longer term.
– Get to know your suppliers so you can understand what is important to them – there may be ways you can help them over and above just buying from them.
– They may be interested for example in a long term commitment or a regular buying commitment that helps them plan and give you better payment terms in exchange
– If your suppliers are bigger companies they may be a source of finance for you – they may be interested to do a more formal collaboration.
To reduce the risk of over-trading and running out of working capital, keep your financial forecasts up to date and especially your cash flow. Review them regularly if you sense you are running out of Working Capital. There are some good new online forecasting tools to help you like Float and Brixx
If your forecasts show you do need more working capital historically it was the banks that funded working capital with overdrafts – however these are much harder to get now. An alternative is the new online invoice discounting firms such as Market Invoice – they advance money against your invoices. But like all providers of finance they wont be impressed if you don’t give them enough time to review your case ie if you say you need the money next week…
Enjoy the festive period – count the calories to avoid over-eating and use the time to identify your potential working capital needs in 2017 to avoid over-trading.