Cash flow is the lifeblood of any business. Like petrol in a motor vehicle – you need cash to get a business started and you will always need what is known as ‘Working Capital’ to keep it going. Without cash to work with, your business comes to a grinding halt.
This is why so many businesses, when cash strapped due to late payments, turn to Invoice Factoring to give them Working Capital to continue, but let’s not get ahead of ourselves. For the uninitiated let’s take a look at what a Working Capital Cycle is, why it’s so important to manage it well, how to calculate the Working Capital Cycle – and finally why Invoice Factoring and the Working Capital Cycle so greatly complement each other.
What is Working Capital?
I quite like this definition from one Financial authority – ‘The Working Capital Cycle (WCC) is the time it takes to convert net current assets and current liabilities (e.g. purchased stock) into cash. A long cycle means tying up capital for a longer time without earning a return. Short cycles allow your business to free up cash faster and to be more agile.’
It is advantageous to free up cash faster and this is often where Invoice Factoring comes in, but I digress, let’s learn a little more about the Working Capital Cycle (WCC) and Working Capital management first…
Why is Working Capital management so important?
It is important to manage working capital for various reasons, but essentially good Working Capital management ensures that your business maintains an adequate cash flow to support operational activities and short-term obligations – as well as optimising your growth.
How is the WCC calculated?
It is about understanding and leveraging your current assets and liabilities so there are 3 parts of the WCC are…
- Inventory – The length of time it takes to sell your inventory.
- Debtors – What your customers owe you and how long do they take to pay you after you’ve made the sale.
- Creditors – How long after you’ve received the goods from your suppliers do they allow you to make payment. This is called creditors days outstanding.
To calculate the Working Capital Cycle, simply add the number of inventory days to your debtors days, then subtract the number of creditors days. In short, how many days does it take you to turn your upfront cash investment into inventory, make the sale to your customer, get paid and ending up once more with cash in your bank. This cycle repeats itself and your cash balance should increase over time.
Where Invoice factoring comes in
Let’s take a simple but clear illustration of a typical SME scenario:
A business secures a great deal with a large JSE listed buyer for goods that need to be manufactured. The order is made but the SME must manufacture the goods to deliver the order.
The SME takes 1 month to manufacture the goods and once the goods are completed it will take an additional 2 weeks to deliver the goods to the buyer. So, we are looking at 6 weeks that the working capital of the supplier is tied up in the process, but unfortunately, that’s not the end of it. On delivery, the supplier can issue an invoice but the buyer will pay only 30 to 60 days thereafter.
Now potentially the supplier’s cash flow or working capital is tied up for double the amount of time it takes to manufacture and deliver the goods, leaving the supplier very cash-strapped and unable to supply new orders for that period.
Invoice Factoring greatly alleviates the supplier’s dilemma because at the point of invoicing he can factor (loan on) his invoice to the client for up to 75% of its value, giving him that vital cash flow back again in half the time. The businesses’ lifeblood is restored!
Consult with the experts
If you find yourself running out of cash because you’re waiting for the Working Capital Cycle to finish, or if you wish to know any more about Working Capital Cycles or management, or exactly how Invoice Factoring and the Working Capital Cycle can greatly benefit your business, please don’t hesitate to contact Finrock Capital, the Invoice Factoring experts.
Invoice Factoring provides a much-needed lifeline for SMEs that want to get a firm grasp on their working capital. It is gaining great traction among small businesses thanks to its convenient process, flexibility and fast access to capital, so talk to us today!
