The ROI of Smooth Working Capital


Andrew Ishimaru

Low-code tools are going mainstream

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Multilingual NLP will grow

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Combining supervised and unsupervised machine learning methods

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Automating customer service: Tagging tickets and new era of chatbots

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Detecting fake news and cyber-bullying

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Your business model is, in the purest accounting sense, how you link together your receivables and your payables.

Customers pay you money for goods & services.

You pay people for their time and suppliers for the goods you sell.

And make capital investments into things that improve your ability to produce more goods & services at lower cost.

What's left over is profit.

Along the way, you front the money to make this whole trade work.

Buying product from suppliers before it gets sold to customers.

Paying software engineers to build integrations and features prospective customers want.

Buying heavy machinery and trucks and tools and factories and servers in advance of when you need them.

Paying salaries for your staff to work on client projects for a month before sending an invoice, which gets paid after the fact.

And in order to do this, you need cash, often times before you get paid by customers.

Modern accounting has abstracted away this concept by simply calling it 'working capital', ie money you keep in the business to make it run smoothly.

The world likes to run smooth & easy. Things just 'work'. Employees get paid on time. Packages arrive 2 hours after ordering. SLAs promise five 9s of uptime.

This is made possible by business owners investing capital in the smoothness of their operation.

Employees get paid and never worry about the stress of missing payroll because a client didn't pay an invoice. (Which is the worst, and keeps every business owner up at night)

In turn, staff can show up un-worried about the stresses of the business and do a good job with quality service.

Clients then feel good about the work, feel good about their vendor, and pay invoices in reasonable time.

Smoothness = 5 star reviews.

Late work, bad attitudes, shoddy craftsmanship = 1 star reviews.

Smooth is good business, made possible by the mechanism of sufficient working capital in the business for cash to move when it needs to.

And with a good business model you don't need to sock away profits into your working capital to keep your business alive.

Money comes in, expenses are paid, and profit is realized right away.

For example, when I owned a marketing agency, we ran our writing team on an hourly work-based contractor model where writers allocated 2 or 3 hours to write an article at a fixed per-hour rate. They delivered the work and invoiced us. And then we invoiced the client for the same amount of hours at the agency rate.

Clients paid the agency first, then we paid the writers.

Because we tied everything to hours, and timed payments when cash actually moved, we had perfectly neutral cashflow for that service line.

It was a good model.

But, most business owners pay staff and buy product in advance, and get paid after product is delivered and work is done.

And my old agency was no exception.

We had other service lines that operated on that model too.

So how to keep your business run with smooth working capital?

Here's a few ways:

  1. Keep a lot of cash (safe, expensive)
  2. Run a business model that connects timing of receivables to payables
  3. Use debt like lines of credit to bridge the gap between receivables and payables (risky, expensive)
  4. Finance capital investments (risky, expensive)
  5. Make your operations more efficient so you require less working capital (difficult, but pays off)
  6. Negotiate agreements with suppliers and contractors that give you a negative cashflow conversion cycle
  7. Push for better payment terms with customers
  8. Collect cash up-front, not after work is done
  9. Take pre-orders. Sell gift cards
  10. Drop net-60 to net-30 or net-15
  11. Put credit cards on file
  12. Pre-bucket your core/fixed & variable costs so you know what to cut quickly if revenue unexpectedly drops, dropping variables costs in line with revenue as close in time as possible
  13. Similarly, have a plan to quickly increase resources using contractors, vendors, etc. if revenue unexpectedly increases in order to service customers without committing a large increase in operating costs or capital investment

As a business owner, you need to pull cash out to pay for things.

Unexpected expenses come up.

Revenue rises and falls.

So the name of the game is about reducing the cash you need to front to run a smooth business, while properly managing the associated risks & liabilities.

Hugely important! For every business move you make, there is always an equal and opposite risk + liability somewhere in the system. This is the spiritual nature of double entry accounting.

If you accept cash up-front, you get the money now but have an obligation to perform the work later, which has costs in the future.

If you take inventory on long payment terms, you get the inventory without paying for it now, but have an obligation to pay it in the future.

If you pay an employee's salary up front for the year to help them pay for a new house, you buy goodwill but run the risk they won't do their job well or might ghost you.

If you charge credit cards on file for payments, that creates certainty for payment but sometimes they expire, decline, and need to be collected on, which is a non-zero risk-weighted use of cash in the future that you probably won't think about today.

But. Properly managed, these risk & liabilities represent the bumps you smooth out to reshape the surface of your working capital.

It ain't easy.

But it's a beautiful thing when you're driving down the smooth, freshly paved blacktop of your capital investments.

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