Working Capital Pt. 2
In the first part of the working capital post, we examined the basics of working capital and how it may help to place a value on your business. Working capital can be a good indicator of efficiency and viability of a company. Another part of working capital that is frequently examined by owners, investors, and bankers is working capital cycle.
Working capital cycle is the amount of time it takes to convert net current assets and current liabilities into cash. The longer the cycle, the longer a company will have their money tied up in capital without earning any return on it. A company should always have some long-term assets and liabilities without a quick return on the capital; however, companies should continue to work toward lowering their working capital cycle by collecting receivables faster or prolonging payables where possible.
Furthermore, it is imperative to understand that the longer the working capital cycle is, the longer a business is tied up in capital without a return on it. For instance, a company that pays suppliers within 50 days but takes 100 days to collect on the company’s receivables has a working capital cycle of 50 days. During this time, the company will likely need to find a bank to provide an operating line of credit or something similar.
Keeping a low working capital cycle is important, but can sometimes be difficult to do for new businesses. If you need help examining your working capital cycle, or help valuing your company, contact us at the Center for Financial, Legal & Tax Planning, Inc.