Working Capital, it's so simple.
Cashflow is key to any business, and having enough working capital to keep a business afloat is critical. What I have discovered in the last 3 months is that it is much harder to truly understand working capital until you are living it. The pressure of having to make payroll and not having enough money in the bank is real and terrifying. Here is my journey, trying to understand the working capital required in my business.
The seller estimated working capital at one month of revenue, which seemed reasonable. I attempted to ascertain this by looking at monthly revenue and yearly profit & loss (P&L) statements. It was not all that clear.
When I applied for the loan, I used the seller’s estimated working capital. I initially wanted all the working capital money to be as an interest only line of credit. The SBA allows for this type of loan when you are buying a business, and it is relatively inexpensive. My plan and request was for an additional $50K to cover if anything came out that was out of the ordinary. I truly did not understand the working capital of this business.
To access the working capital myself, I looked at the month by month revenue, and compared outgoing to incoming revenue. I also looked at the yearly P&L’s to see if total revenue was supported by the monthly numbers. My estimated expenses per month were 88% of the revenue, which included my salary. All signs pointed to this being inline with expectations.
Then, as the expenses started stacking up, it occurred to me that I had made some underestimates in the needed working capital. The realization that the projected working capital was not going to cut it, as I chewed through the working capital with no end in sight. Each additional request for more loan money as my line of credit diminished made me more and more nervous.
Some truths about the business became more apparent now, 3 months in. During due diligence, I knew the project-based portion of the business was lumpy, and had its ups and downs. The lumps, though, always resulted in a healthy amount of revenue by year’s end. I figured I could handle these by being prudent and growing the business.
A couple of things got me into a precarious spot with working capital. First, the extra expense of closing with bank fees being higher than projected. Additionally, my lawyer’s bill being higher than expected due to unnecessary back and forth between the lawyers. This lowered my working capital at close. Also, the wonderful FED that has raised the interest rate to crush the economy, which even before my first loan payment raised my loan payments not insignificantly. In the FED’s infinite wisdom they raised it again, and next month is going up again.
I would not even have had working capital at close, had the loan underwriter not suggested that I have both line of credit working capital, and some worked into the initial loan. My initial reluctance for adding this long-term debt was overcome, by the loan underwriters story of having a working capital crunch of his own when he ran a business. This meant in addition to 1 month of revenue + $50K working capital, I also received 1 month of revenue from the start. The bank asked why I needed both, and I told them that the line of credit was needed for growth.
This additional money ended up being critical as I did not fully understand the working capital requirements of the business. An example, for one of the projects which was a $50K sale of custom handrails, I had to outlay $11K of money the week I bought the business to buy the materials via wire transfer. This was unusual because usually, our suppliers are on NET 30 terms with us (aka we would have 30 days to pay). Then over the next month I had to pay the wages of the team, including the overhead, as they completed this work. I delivered these handrails to the customer, and invoiced them with our usual NET 30 terms. We didn’t get paid for 50 days because the customer had not gotten paid by their customer, the county government. Start to finish, money was outlaid for over 3 months before it came back.
Where does this leave my company currently? We are finally receiving some of those checks from work delivered months back. Presently, we still have a small buffer in the line of credit. Our accounts receivable is healthy, so barring any other unforeseen circumstances we should have achieved steady state.
This situation has me evaluating just what kind of growth the business should be seeking. Many wise people have said if you run out of working capital even with plenty of business you can easily go out of business. More growth in the same vein as the example I chronicled above could lead to such a situation.
This has led me to plan to expand into some work that has the opposite cashflow characteristics. Namely, getting the money upfront before the materials, or wages are outlaid. Sounds easy right? I am not certain it will be easy, but plan to continue to journal my success here. So if you are enjoying this content, why not do me a favor and recommend it to your friends.