Geo Killian, tax attorney at Hobbs Sinclair advises on important property tax matters in this featured article; Navigating your tax obligations when buying a property in SA as a foreigner or expat.
In order to have a healthy working capital, a business needs to make sure that it has enough capital to pay for day-to-day running costs.
Working Capital is the interaction between a company’s assets and liabilities. It’s important to assess the financial position of your business to ensure that you have sufficient working capital. There are two cycles operating in your business; an investment cycle supported by long term assets and liabilities and a business cycle supported by current assets and liabilities. A general rule is for your long term assets to be matched with long term debt and the loan taken to purchase current assets to be honoured in less than 12 months. I like to advise clients that they should match the use of an asset to the payback period. For example, if you purchase a printer and finance the repayments over 3 years, the printer should last you three years at least. The availability or scarcity of working capital is going to make or break your business and it all boils down to your value chain and how efficiently you get that to work for you.
To contextualise; you need cash to fund the day to day activities in your business. If you have too much working capital the returns on that cash will decrease – this excess cash would be better utilised towards settling any debt or returning it to shareholders. If you have too little cash, the business cannot fulfil its obligations in the short term and is effectively distressed despite any profits.
Working capital management entails managing the interaction between inventory, trade debtors and sales as well as trade payable and purchases. A simple guide is to sell your inventory as fast as possible with the quickest payment from customers and settle your creditors as late as possible with a discount. Obviously the above works well in an ideal world, but your customers and suppliers will be looking for the same advantage. You will have to compromise on this guideline and where you set the compromise will have an effect on how much working capital you have available, affecting the speed of your business. The faster you can speed up the cycle, the more profitable your business will be.
If your business working capital cycle is:
Inventory – 30 days (Stock is on your shelves for 30 days)
Debtors – 120 days (you give debtors 120 days to pay)
Creditors – 30 days (you settle creditors in 30 days)
Working Capital cycle = 90 days
In the above scenario, your working capital cycle is 90 days, effectively making profit four times a year, meaning your working capital will be turned over four times a year. If you reduce those days to 60 days your working capital will be turned over six times, a 50 percent increase in profit for less risk and the same investment in working capital.
The faster and more efficiently you complete that value chain cycle, the faster you can grow your business if the re-investment in working capital can increase profitability, ideally alleviating the need for a loan.
We all want to live in a debt free world. It doesn’t take an accountant to tell you that finance costs money, it’s expensive to lend. If you use your structure carefully and orchestrate your creditor pay- back period cleverly, you can alleviate the need to finance operations and assets. De-risking your business is not a hard task; it’s more a matter of getting the business to work for you. Having the right amount of working capital is imperative for success, not only does it ease the mind by alleviating financial stress, but it also saves you money.
Not having a grip on the speed of your value chain is costing you money.
Greig Sinclair
Partner, Hobbs Sinclair Chartered Accountants
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