With startups you always deal with financing: Trying to raise capital, applying for grants and loans, watching your burn rate and so on. Considering how strongly the financial resources are present in running a startup, it is surprising how little attention is paid on how much of the capital is tied up in working capital requirements.
Why would you have one months expenses worth of funds being tied up in working capital when those could be used to grow your business?
Optimizing your working capital can free significant funds that can be used to grow your business. Just having all the months expenses at the beginning of the month and incomes at the end of the month ties one month’s expenses worth of funds into working capital. Think about how much effort it would take from you to raise the corresponding amount from the investors!
Accelerating or decelerating growth?
Also, having a working capital requiring business will slow down your growth: Instead of investing 100% of the profits into growing the business, a part of profits needs to be used to cover the increased working capital requirements. On the other hand, running your business with negative working capital (yes, that is possible) accelerates your growth even further.
Optimizing working capital
In short, you need to things to optimize your working capital:
Accelerate cash flow in as much as possible
Delay cash flow out as much as possible
The optimization should be done in two dimensions: within month and within year. To do this, you need to check
Where your cash is coming from;
Where is it going; and
What things are in your control relating.
You can accelerate cash in by e.g. invoicing earlier and using shorter payment terms; advance payments can be cool too. Delaying expenses can be done by e.g. paying salaries at the end of the month, agreeing supplier delivery and invoicing dates that suit your business cycle and so on. These are case by case items and depend a lot about your business and operations, but usually you can find something in the following areas.
Cash in (income and collection of receivables)
Customer payment terms
Collection procedures and factoring
Cash out (expenses and payment of liabilities)
Salary payment date
Supplier payment terms
Pension payment plan