I’ve written previously about the importance of a business being adequately capitalized. The businesses that are still standing and the new ones that have started up since the Great Recession find themselves in an extremely competitive market. New accounts can be hard to come by, there is still quite a bit of pressure on profit margins, and competitors are actively pursuing your people and your accounts.
Many businesses in this market are still struggling to thrive because of a lack of working capital. Through this series of posts we will discuss how a lack of capital will hold back your business and what you can do to increase your working capital.
How a Lack of Capital Limits Sales.
In every business there are two types of costs: variable and fixed. Your variable costs are costs that depend on how much you produce. These can be things from raw materials to the commissions you pay your sales people. They are typically listed as “Cost of Goods Sold” (COGS) or “Cost of Sales” on your Income Statement or Profit and Loss (P&L). Fixed costs can range from salaries to staples, from tissues to telephones, and are usually referred to as overhead. These are labeled under the “Expenses” section of your P&L statement.
Every business has a set level of fixed costs, or overhead. We often refer to these as the costs to turn the lights on. With $350,000 in fixed costs, let’s say a business can handle up to $2 million in sales.
However, because a line of credit from the bank is limited by a business’s equity, cash flow, or even the owner’s personal credit score, maybe the business is only able to do $1 million in sales each year. Because it lacks working capital, the business is only marginally profitable. But, if the business can increase its working capital, it can increase its sales to $2 million. Because the only real costs for this increase in sales are its variable costs, the additional sales are mostly profit. As a result of increased working capital a marginally profitable business has quickly become a very profitable business.
Let’s look at a quick example of how a lack of capital hurts and the solution to that problem.
Joe’s Trucking Company owns three trucks and hauls loads from Minnesota to North Dakota weekly. The lease payments on the trucks and the dispatcher in the office are both fixed costs. The dispatcher is a fixed cost because she needs to be there all week for when new loads come in. The trucks are a fixed cost because they are leased and the payment is the same each month. The main variable costs for Joe’s Trucking Company are fuel and driver pay.
Currently Joe’s Trucking Company is waiting 45 days to get paid on their invoices. Because they are waiting to get paid on their loads, they can’t always keep their trucks moving. Since they are already paying the dispatcher and the truck leases are a flat rate, unused trucks are a wasted opportunity. If they can turn their invoices into cash quicker, then they will have the working capital to pay their drivers and fill up with fuel. With that cash, they can increase the number of hours that their trucks are moving. And by keeping their trucks moving, with the same set of fixed costs, Joe’s Trucking Company can maximize their sales and maximize their profit.
Do you have a business that is stuck with a lack of working capital like Joe’s Trucking Company?
It’s common for the growth of a business to be limited by a lack of working capital. If you’ve found yourself in a situation similar to Joe’s, where you can grow your sales by having more working capital, let’s talk. At Commonwealth Capital, we help our clients solve the challenges brought about by a lack of working capital. By turning invoices into cash and proactively managing receivables, we are focused on helping our clients grow.
- There’s actually an equation that can be done to figure out the proper number of items to produce to maximize your profit. This, however, isn’t a math blog, so I left it out. If you’d like to learn more, you can reach out to me. ↩