By James Nicholson-Smith, Business Development Director & Managing Principal, West Midlands Region, The FD Centre
‘Working Capital’ and ‘Working Capital requirement' are 2 phrases that drive the majority of entrepreneurs mad. As concepts that are continually referred to by bank managers and risk assessment teams at credit insurers, they seem completely alien to the sales revenue and costs which all entrepreneurs live and breath every day.
In an attempt to demystify the concept of working capital for differing types of businesses, it is worth putting the subject into the context of contractual negotiations. To try and illustrate the different dynamics we will use 2 businesses with very different business models.
Meet Trading Limited. They buy unbranded toy products from suppliers in the UK, Germany as well as product from China. These products are then sold to a number of retailers and etailers. They work very closely with Product Marketing Limited designers of all their product packaging.
The two parties negotiate annually for their requirements. Typically Trading Ltd represents 10% of Product Marketing Ltd’s annual business. As a business owner yourself, you may recognise your own situation in the following conversation.
A different interpretation of manageable working capital
“So in summary, over the last 12 months we have spent £145,000 with you compared with our budget of £150,000. During a recession that is not bad” concludes Bob Miles, Managing director of Trading Ltd after a long drawn out summary of the projects undertaken.
“I agree that Product Marketing is very happy with the relationship, although this year the projects have been much more seasonal and last minute than previous years and it has taken a lot longer to get paid. This has increased our costs because we could not plan our staff levels very effectively and more of our cash was tied up.” Replied Stuart Small, Senior Partner from Product Marketing clearly anxious to even up the context of the discussions before pricing and terms for the year ahead commenced.
Working capital management for a consultancy business
Stuart continued “The issue for us is that we are employing staff and are paying them a net salary at the end of each month. We then pay the income tax and national insurance 19 days later. This happens regardless of whether we do any work for you or not. As you represent 10% of our business that means that on average 1 hour in every 10 for each of our staff is spent working for you.
The average size of a project is £25k and the length of a project is 8 weeks. At present we are invoicing you for that work when the job is complete. What is currently happening is that we are doing that work in the 8-week period and then you want some minor amendments, which typically take us another 4 weeks to resolve and finalise. The invoice then comes to you about 5 days later and is paid 30 days from the end of that month.
As a result we will have paid 3 months of salary and 2 month of tax and NI before we even raise the invoice. This is after allowing for our rents and IT leases which are all paid at the end of each month. As you can see from out accounts we historically make about 10% net profit. Therefore we are effectively investing £22,500 of our working capital into each of your projects over a period of 2 months and then waiting another 3 months before we are paid for it.
We are a product marketing company and not a bank. In the current economic climate, we cannot afford to fund your business for that length of time. We would like to introduce stage payments for this year?”
As the largest provider of part-time Finance Directors in the UK, the FD Centre can help businesses achieve their strategic objectives. To find out if your business could benefit from a FREE Business Strategic Review and receive valuable advice for your business’s financial planning, visit www.thefdcentre.co.uk
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