Almost every business owner I speak to at the moment is having issues with their cash flow and unfortunately more business’s will fail in 2010. You can have thousands of great customers and make huge profits but without cash flowing through the busines it will fail. Despite what the advertisements say Banks are still declining lots of loan/ overdraft applications so micromanaging working capital is critical.
Firstly what is working capital? Working Capital is loosesly regarded as: Current Assets – Current Liabilities
Managing working capital involves ensuring the business remains liquid by balancing the need to keep adequate cash to meet obligations on one hand and on the other hand not being too conservative and utilising the available funds.
Sounds good but how can we do it, Most important is the matching concept (sounds exciting doesnt it) This means long term assets (fixed assets: Buildings , vehicles ect..) must be financed by long term funds, (Debt/ Equity) , Short term assets can be financed with short term funds (Creditors/ Overdraft).
Mis-matching can have lead to serious issues, for example if a long term asset is purchased using an overdraft, The overdraft may expire due to a change in circumstances. This could have disastrous effects for the company.
Working capital management is crucial to liquidity. To assess the liquidity of a company we can use the current ratio:
Current Ratio= Current Assets/Current Liabilites
The ‘prefect/ideal world (never happens!)’ current Ratio is 2:1 so even if the current assets halved their would be funds remaining to pay creditors but presently in business in Ireland 2010 any figure above 1.5 is very healthy. If the current ratio falls below 1:1 there is likely to be serious liquidity issues.
If you would like a free consultation on your companies cash flow situation please email me at:
This is the Blog of an Accountant based in Galway providing Bookkeeping services and accountancy software