Working Capital: Why It Matters When Selling Your Business
By: Brett Pittsenbargar
Working capital is the key to the success of your business because it reflects the efficiency of how you manage your small business. When you have a proper management system in place, it is highly likely that your business’ financial health will be impressive. This can translate to better profits and greater probability of operational success.
Working capital is an essential asset that all small business owners should be monitoring. It will not only allow small business owners to assess the performance of their company, it will also give a wider understanding on how to maintain that tricky balance between their company’s growth, profitability, and liquidity.
What is Working Capital?
According to the Bank of America, your “working capital tells you how much money you have readily available to meet your current expenses”. In short, it is the measures which defines how much operating liquidity you have as a small business owner. You can determine your working capital by using the following formula:
Working Capital = current assets – current liabilities
When you say current assets, it means those short-term assets that you can immediately turn into cash; examples of these are accounts receivables and inventories. And when you say current liabilities, it refers to the amount of your debt or obligations that you are expected to be settled in cash in a certain time period; examples of these are accounts payable and short-term debts.
You shouldn’t allow your current liabilities to exceed your current assets. Thus, if you are a small business owner, your goal is to have a positive working capital. A positive working capital means that your small business have more money than what you need at a given moment. Of course, you need to have enough working capital in order to cover your business’ expenses. The challenge now is to maintain enough liquidity in your small business to ensure that its long-term growth.
Why is Working Capital Important To My Small Business?
Working Capital can be likened to our body’s blood – it is needed to keep the body’s rhythm at pace, it is needed to fuel other organs and the heart pumping, it is needed for us to stay alive. Much like how the body needs blood to survive and stay healthy, your working capital is also vital and highly essential to your business to ensure its survival.
With a negative or non-existent working capital, your small business will not be able to run properly: losses in assets will increase, debts will increase, and problems will pile up. In the end, you might even declare bankruptcy – a situation wherein all small business owners wouldn’t want to get into. So, Working Capital is really important because it determines the life-cycle of your business.
When considering the future sale of your company, understand that working capital is a key component when determining the valuation. This is a primer in the diligence process.
Sustaining good Working Capital will allow you to balance your small business’ assets and liabilities which roughly suggests covering financial obligations while maintaining that much-needed boost in earnings. Sounds great, right? Aside from, a good working capital can also bring many advantages to your business, some of these are the following:
Higher Profitability and Liquidity
Higher Financial Freedom
Easier to Obtain Loans because of Improved Credit Profile
Uninterrupted Supply of Raw Materials and Production
Smooth Business Operations
Higher Ability to Solve Crisis and Face Shocks
Why is a Working Capital necessary in Selling my Business?
Working the Working Capital is a lot of hard work! That means that you, as a small business owner and seller, should retain and sustain a positive working capital. This is what will convince buyers to buy your business. Remember, a buyer will not strike a deal with a company that is always yielding a negative working capital; because it is like saying that they are buying debts or obligations.
Robert Moore, a Partner in RSM US LLP (auditing, tax, and consulting firm), said that a “working capital is critically important in the operation of a business and is often implicit in determining a company’s value”. Since the working capital has a direct effect on the value of a business, it is also a crucial determinant on how much will your business sell. This will be determined when you negotiate with a buyer, the working capital will also affect how the buyer will want to purchase your business.
In negotiating a deal with your buyer, you must note that a buyer will look at the general trend of your working capital. The general trends are:
Seasonal Working Capital – These are businesses with highly seasonal sales
Growth Working Capital – These are businesses whose receivables and inventories keep growing each month, requiring its working capital to grow alongside the need for sales
Negative Working Capital – These are businesses who have much obligations; they are also companies who receives payment before rendering a service or a product
Erratic Working Capital – These are businesses who have large-paying customers that usually change payment habits or terms
Depending on these trends, the buyer will analyze how will he/she can profit from the purchase. You must also be prepared to answer questions regarding these trends and the working capital as a whole. Buyers are strategic thinkers: they will only buy businesses that they know that they can profit from.
Again, your working capital is the lifeblood of your business. It will determine how healthy your business is and how marketable it is. The Working Capital will always be an element that a buyer will look for in your business. So, work on the Working Capital. And work hard!
Brett Pittsenbargar is a savvy business investor and turnaround strategist dedicated to assisting business owners reach their objective at every growth phase. With a background in business development and investment experience, Pittsenbargar understands that business is much more than written contracts, it is about the people working every day in the business that matter most for small and medium sized enterprises generating $1-20 million in revenue annually. He invests in, mergers and acquisitions, growth partnerships, cash out purchases and adding shareholder value.
Consult with a seasoned business investor that has decades of experience helping small and mid-sized businesses. A business strategist who can work directly with you in developing exit strategy plans, partnering growth partnership, building shareholder value and organizing mergers is critical for your business. Contact Growth Point Holdings today to arrange a one-on-one consultation with a dedicated business strategist to start building a synergistic long-term business relationship together.
Disclaimer: This article is intended to give you general business information, not to provide specific legal or financial advice. Be sure to consult your attorney, accountant, and financial professionals for any specific questions relating to your business.