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What is Working Capital · Enhance.training

• 0:00
  SPEAKER_00: Working capital.
• 0:02
  SPEAKER_00: What is it and why should I care about it?
• 0:05
  SPEAKER_00: Working capital is the biggest investment most businesses make, sometimes without realizing it.
• 0:10
  SPEAKER_00: Don't manage your working capital well and your business could fail.
• 0:15
  SPEAKER_00: In this podcast, we're going to explain exactly what working capital is using everyday language and share some simple examples.
• 0:23
  SPEAKER_00: Working capital is an accounting term, but don't let that put you off.
• 0:27
  SPEAKER_00: My name is Jess Coles, and I teach business owners and managers how to manage businesses more effectively.
• 0:34
  SPEAKER_00: Results I've delivered include adding over£50 million in cash from improving working capital management across a variety of businesses.
• 0:44
  SPEAKER_00: If you are new to this channel, enhanced.training provides online business courses to help professionals, managers and business owners improve their performance.
• 0:54
  SPEAKER_00: If you like this podcast, please share it with friends and colleagues and visit us at enhanced.training for more great tips on transforming your performance.
• 1:05
  SPEAKER_00: If you are a business owner or business manager or a manager within a business, the decisions you make will impact working capital.
• 1:14
  SPEAKER_00: So what is working capital?
• 1:16
  SPEAKER_00: Working capital is the cash investment that you need to make before you can sell an item to make a profit.
• 1:24
  SPEAKER_00: Let's take making a smoothie as an example.
• 1:27
  SPEAKER_00: You've done your market research and you know you can sell the smoothie once made for eight pounds.
• 1:34
  SPEAKER_00: To make the smoothie you need fruit and a blender would be also really handy.
• 1:39
  SPEAKER_00: So before you start you need to buy fruit.
• 1:42
  SPEAKER_00: Let's say the fruit costs you four pounds for each smoothie that you want to make.
• 1:47
  SPEAKER_00: So at this point you have not sold anything but you've had to have paid out at least four pounds.
• 1:54
  SPEAKER_00: If you didn't have four pounds, you would not be able to buy the fruit and make your first smoothie.
• 2:00
  SPEAKER_00: You'll probably need to use a blender to get a good smoothie.
• 2:03
  SPEAKER_00: A lower cost option might be to use a fork to mash the fruit, but rather you than me.
• 2:09
  SPEAKER_00: And you might not be able to get£8 as your sale price if there are lots of big lumps in the smoothie.
• 2:14
  SPEAKER_00: So let's assume you rent a blender and the cost will be£1 per smoothie made paid in advance just to make things simple.
• 2:23
  SPEAKER_00: So to make one smoothie and give yourself the chance to sell it for£8, you need£5 in your pocket to start with.
• 2:30
  SPEAKER_00: This five pounds is your working capital.
• 2:33
  SPEAKER_00: Hopefully this makes sense.
• 2:36
  SPEAKER_00: Working capital is the accounting term for the cash investment you need to make to get a product ready to sell.
• 2:44
  SPEAKER_00: Having made and sold your smoothie, you would then have eight pounds in your pocket and you could buy more fruit and make another smoothie to sell.
• 2:52
  SPEAKER_00: After this, you could then afford to make two smoothies at the same time, and so you start growing your business.
• 2:59
  SPEAKER_00: To speed this process up, you might tack out a loan so you can make 20 smoothies at a time to start with, for example.
• 3:07
  SPEAKER_00: So let's take a deeper look into the cash challenges of running a business.
• 3:12
  SPEAKER_00: A common error made by too many people is that they assume that earning a profit is the same as earning cash.
• 3:20
  SPEAKER_00: Profit and cash are not the same.
• 3:22
  SPEAKER_00: There is nearly always a timing difference between when you earn a profit and when you collect the cash.
• 3:29
  SPEAKER_00: Everyone is taught that profit is the key thing to track in business, yet, as every business owner knows, you can't spend profit.
• 3:38
  SPEAKER_00: You need cash to pay the wages, invest in that new product, pay for advertising, etc.
• 3:44
  SPEAKER_00: The timing differences occur because profits are a product of accounting rules.
• 3:49
  SPEAKER_00: Profits are a measurement of success and they're a very important tool.
• 3:54
  SPEAKER_00: But cash is real.
• 3:55
  SPEAKER_00: It is either in your bank account or it is not.
• 3:58
  SPEAKER_00: It is that simple.
• 4:00
  SPEAKER_00: To explore this in more depth, we suggest you visit enhance.training and go to articles.
• 4:07
  SPEAKER_00: In our What is Working Capital article, we have some great diagrams that show these timing differences in an easy to understand way.
• 4:15
  SPEAKER_00: In most businesses, you typically earn a profit before you get the cash into your bank account.
• 4:22
  SPEAKER_00: So now you understand what working capital is, let's discuss how working out capital impacts your growth.
• 4:30
  SPEAKER_00: In nearly all businesses, the faster your growth, the more cash you need to have available to invest in growth.
• 4:38
  SPEAKER_00: Or in accounting terms, the bigger your working capital investment will need to be.
• 4:43
  SPEAKER_00: Going back to the smoothie example, if you make one smoothie at a time, you need to invest£5 in your business.
• 4:51
  SPEAKER_00: If you made two smoothies at the same time, you would need£10.
• 4:55
  SPEAKER_00: And if you made£100 smoothies in one go, then your investment would be£500, ignoring any efficiency opportunities of course.
• 5:03
  SPEAKER_00: This simple example demonstrates the faster you grow, the bigger your cash investment needs to be.
• 5:09
  SPEAKER_00: And of course, there are many ways to get cash from profits, from investors, from bank loans and overdrafts and so on.
• 5:17
  SPEAKER_00: Assuming you have enough customers to buy your product, then how much cash you have available to invest in working capital is usually the next limiting factor in your business growth for the reasons shown above.
• 5:32
  SPEAKER_00: As working capital is likely to be one of your largest investments, it makes sense to take steps to manage this investment.
• 5:41
  SPEAKER_00: There are many ways to reduce your investment in working capital.
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  SPEAKER_00: Most of these steps aim to do one or more of these three things.
• 5:49
  SPEAKER_00: Firstly, get customers to pay earlier.
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  SPEAKER_00: Secondly, get suppliers to accept payments later.
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  SPEAKER_00: And third, to reduce the amount of product you need to keep before selling it, or in accounting terms, to reduce your stock or inventory.
• 6:07
  SPEAKER_00: There can be a tough balancing app between the above three aims and generating profit and growing sales.
• 6:14
  SPEAKER_00: Each business chooses a slightly different balance between these five areas.
• 6:19
  SPEAKER_00: Get this balance wrong and your business can fail because the business runs out of cash.
• 6:24
  SPEAKER_00: For this reason, it pays to spend time managing your working capital and running cash flow forecasts to check that you have plenty of cash available to support your business plans and its growth.
• 6:36
  SPEAKER_00: More businesses fail while in growth than in decline.
• 6:41
  SPEAKER_00: This shows you how important managing working capital is and why understanding how working capital impacts your business will help you personally no matter what level you are within the business.
• 6:53
  SPEAKER_00: I'd quickly like to mention negative working capital.
• 6:58
  SPEAKER_00: There are some businesses that get paid before they have to pay anything out.
• 7:03
  SPEAKER_00: This is called having negative working capital.
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  SPEAKER_00: This can be a really important competitive advantage for your business.
• 7:12
  SPEAKER_00: In our article on working capital on our website enhanced.
• 7:22
  SPEAKER_00: Let's look at an example.
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  SPEAKER_00: Food supermarkets are great examples of businesses with negative working capital.
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  SPEAKER_00: And let's go through why quickly.
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  SPEAKER_00: Supermarket customers pay in cash or by card before they leave the store.
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  SPEAKER_00: Therefore, the supermarket has this cash in its bank account within a day or two of the sale.
• 7:44
  SPEAKER_00: They get their customers to pay very quickly.
• 7:48
  SPEAKER_00: In addition, each supermarket keeps the amount of products in storage, i.e.
• 7:52
  SPEAKER_00: their stock, to a minimum.
• 7:55
  SPEAKER_00: Most of its products are on the shelves to be sold at any one point, and the store takes deliveries of replacement products each day.
• 8:03
  SPEAKER_00: This keeps the product levels down and their cash investment low.
• 8:07
  SPEAKER_00: Lastly, the supermarkets require their suppliers to wait quite a while to get paid, i.e., they get suppliers to accept payments typically 60 days after delivery of their products to the store.
• 8:20
  SPEAKER_00: All these steps mean the supermarkets get paid cash before they have to pay out cash to run their business.
• 8:27
  SPEAKER_00: This is negative working capital.
• 8:30
  SPEAKER_00: The important benefits of having negative working capital are firstly you don't need to invest in your working capital and therefore you have more cash to invest in other areas.
• 8:42
  SPEAKER_00: And secondly, you can grow very quickly as the higher the growth the more cash you get in.
• 8:48
  SPEAKER_00: It's a great business model to have.
• 8:51
  SPEAKER_00: So, in summary, understanding what working capital is and managing working capital are very important aspects of running a business well.
• 9:02
  SPEAKER_00: Many of those businesses that haven't paid enough attention to managing their working capital fail.
• 9:07
  SPEAKER_00: Don't let this be you.
• 9:10
  SPEAKER_00: If you like this podcast, please share it with friends and colleagues, or visit us at enhanced.
• 9:23
  SPEAKER_00: Thanks for listening, and I look forward to speaking to you again soon.