Starting up or Starting Over: Working Capital and Cash Management Tips During COVID-19

Guest post by Andrea Harris, Senior Manager at Buckberger Baerg & Partners LLP

We have become accustomed to hearing 2020 described as unprecedented, unusual, challenging, impossible, and the list goes on. Entrepreneurs can add even more painful adjectives to describe the 2020 experience due to the constant cash flow stress and uncertainty.

You may be starting up, pivoting, or had to press pause on current business operations. So how do we go about surviving these uncertain times? Every business will have different levers it can pull to try to stay resilient, keep clients, salvage sales, scale operations etc. but in the vast majority of cases, it boils down to cash.

I am going to define working capital, look at how it affects your cash flow, and provide tips to effectively manage both.

What is Working Capital?

Think of working capital as the gas in the tank of your car.  You have a vehicle that is perfectly capable of getting you around, but unless there is fuel in the tank, it is completely useless.  In accounting terms, working capital is defined as your current assets, less your current liabilities. Most commonly this includes accounts receivable, inventory, and work in progress less accounts payable, customer deposits, and other accrued liabilities.

In an established and mature business, working capital may stay consistent; you have your regular payments coming in and in turn you pay your employees and vendors. However, after working hard for a year or two, and seeing a positive net income and growth on your income statement, your bank account may remain dry. So where is that profit going? Often the answer is that your growth is funding your increase in working capital, but that isn’t translating into cash. 

To many entrepreneurs this concept may be counterintuitive; how does my rapidly increasing sales and growing company mean I have less cash?

As you stock your shelves, pay your employees, put the open sign up, build a website and social media presence, you deplete cash.  On the other hand it takes time to sell a product or provide a service and then it may take even longer for clients to pay 45, 60, or an even greater number of days later. Each month the expenses continue to be paid, but there is a lag before revenue and collections start coming in sufficient to cover the costs.

In periods of great uncertainty, seasonal business fluctuations, or when a pandemic creates a temporary pause or disruption, that typical working capital in and out, if misread, can turn into a significant strain.  In a situation where you carry receivables and are able to close and bill projects you may see your greatest cash position as your business activity reduces. This is because you are collecting cash for services that you have already had to cash outlay for. Alternatively you may have large amounts of inventory you are unable to sell, or payroll payments to make, as well as, clients who are delaying paying their invoices or simply unable to do so at all.

So as a business owner, what are some specific steps that you can take to manage your working capital?

Working Capital and Your Business

Step one is understanding the demands on your unique business. Map out your cash flows month by month to understand the inflows and outflows.

  • Do you have cash sales or extended payment terms? Estimate how many days, on average, you expect it to take to collect on your sales.
  • What payment terms will your vendors extend to you?
  • How much inventory do you need to run your business?
  • Determine what costs are fixed and what costs could be eliminated or deferred.
    • Complete a break-even analysis on your company

Does your business have seasonality or COVID-19 disruptions? Understanding the peaks and valleys will help you determine the time of year when you will have the most strain on your working capital.

Strategies to Improve Cash Flow

In times of uncertainty buying the ‘optimal’ amount of inventory may be more of an art than a science. Who would have guessed hot tubs, bikes and now cross country skis are the items retailers wished they had overstocked in 2019?

  • If you are starting over, take a look at if you have some inventory you can liquidate, or whether you can run leaner to help with cash flow.
  • If you are starting up, critically weigh the cost benefit of buying in larger quantities vs. operating with a just-in-time model.
  • Monitor your accounts receivable listing and foster communication and positive relationships with your clients to shorten collection time. Clearly state on your invoices your payment terms to reduce confusion. Your clients are your stakeholders and they want to see you succeed and may be willing, if they can, to shorten payment terms if it means you can better serve them.
  • Consider requiring payment up front such as a deposit or retainer for goods and services to be provided.
  • Work with your vendors to understand what payment terms or credit can be extended on their end.

In every case, regular monitoring and communication with your stakeholders will go a long way.

Trusted Advisors and Professionals

You have mapped out your cash flows, and you see you will run into a cash flow problem. Now what? Plan ahead by talking to your financial institution or other lenders to find options available to you. Many financial institutions will offer working capital financing, but need to see your cash flows, business plan and what they will be able to leverage against

Engage with your other trusted professionals such as your accountant to assist with preparing a cash flow and help with advising on cash flow requirements.

If you are starting up or starting over you are not in this alone – lean on your advisors, your mentors, and your peers for inspiration to maintain resilience.

Post by: Andrea Harris, Senior Manager at Buckberger Baerg & Partners LLP

E: aharris@bbllp.ca