18. Why You Should Be Measuring Your Working Capital
Why You Should Be Measuring Your Working Capital
If you need reasons to measure your working capital, here are three.
1. Essential for Cash Flow and Sustainability - A business needs cash to survive. The easiest way to find cash in a business is to look at how they manage their working capital.
2. Better Measures = Better Decisions = Better Outcomes - Not monitoring your working capital is like flying a plane without an altimeter.
3. Warning Signs - It can be an early indicator that there are problems within the business.
Why It's Important To Measure Working Capital
Okay, so now we're going to talk about why it's important to measure working capital. And for, to have a sustainable business, you need to, your business needs to be profitable not only from profit perspective, but also from a cash profit. And so, what makes up the cash profit is your profit and loss plus the essential items of your working capital, your accounts receivable, your inventory, and your accounts payable.
1. Essential for Cash Flow and Sustainability
And so your operations, your cash profit or loss from your operations is really showing you how well you're managing your business. And so, managing your working capital is essential to long term sustainability. So what I'm basically saying, it is possible to go broke while making a profit.
2. Better Measures = Better Decisions = Better Outcomes
The second reason why you wanna measure your working capital, because better measures equals better decisions, better decisions equals better outcomes. So many businesses and also managers in midsize or large organisations, they're, all they're getting is their profit and loss, and they're managing solely on their profit and loss. And they're not looking at, they're not even getting the figures or they're not looking at the working capital.
And so that is the same as flying a plane just solely by speed, and without an altimeter. So when you, when you feel, if you're flying, and you're looking just solely at your speed, and you think you have a problem, what's the only solution you've got? And that's basically to go faster. And that really means if you, and if you're flying a plane and your only solution is to go fast, that means you're really gonna crash quicker.
And that's what happens in a lot of businesses, especially when they're growing, because they're not managing their working capital. So by having, looking at your working capital, it's like having that altimeter to see where you are, or how in your height, whether you're at the right height or whether, what you need to change. So it's giving you more, greater depth to your management and to you're reviewing of the financial statements.
3. Warning Signs
And thirdly, it's a warning sign. So most businesses, especially in the startup stage will struggle because they don't have enough working capital. So they don't have enough cash to cover the expenses coming in and like I said before, growth is one of the greatest killers of cash flow in a business.
So if you're wanting to grow your business, and you don't have the working capital, they're just saying that, you're just going to go quicker. So, what I mean by that is when you're growing a business, your fixed expenses will go up, are faster than your sales.
So if we have a look at the graph here, let's say this is your fix expenses, and this is your sales. Now fix expenses aren't going to stay like that. They might go up like this. You need to hire another person, you need a bigger building. And so your cash flow and your working capital or your accounts receivable's gonna go higher or inventory's gonna go higher, and so that's why you need to monitor here your working capital because just by growing quickly, or your sale's going up does not mean you're going to be, you're gonna make more money, especially from a cash perspective.
So these are the three reasons why it's important to work on your working capital. Essential to sustainability. Better measures equals better decisions, and it's also a good warning sign of how your business is going. Thank you.