How Financially Fit is Your Business: Understanding Working Capital  

Working Capital is something that is scrutinized by almost every company but rarely talked about in the collision industry.

But I guarantee every large MSO in your marketplace is actively managing Working Capital.

It is also something that major vendors will consider if you are negotiating for a pre-bate or other consideration for purchasing their product.

Banks look at it too. If you want to borrow money to grow, they will scrutinize Working Capital to ensure that you can afford the loan.

If you ever sell your business, it will be a hotly negotiated topic as well.

Most business owners do not look at working capital until one of the above situations forces a working capital negotiation. But that is the wrong time to start managing working capital. It is like going on a diet the week before your annual doctor checkup.

Understanding working capital will help you better manage your business, better manage your cash flow, and better manage both vendor and customer relationships. It will also help you better position your business for growth, for acquisitions, or for sale.

What is Working Capital?

Working Capital is the cash required by a business for day to day operations. Working Capital is important because it is a measure of cash flow, albeit a sub-component but perhaps one of the most important sub-components of cash flow.

The most basic iteration of working capital is simply current assets minus current liabilities. In the collision business, a simple way to think of this is the difference between Accounts Receivables (AR) and Accounts Payables (AP).

Working Capital takes into consideration how quickly a company gets paid and how quickly that company must pay its vendors. The more efficient the company manages that “Cash Conversion Cycle” the more financially healthy it is.

How does Working Capital work?

In business we normally want to increase our assets and decrease our liabilities. But in working capital management, you actually want to do the opposite.

When AR is collected, it generates cash and when AP is paid, it consumes cash. AR represents a promise to pay and AP an obligation to pay. AR thus is an asset while AP is a liability.

In order to effectively minimize the working capital required by your business (and thus maximize your cash flow), you want to decrease the asset (AR) and increase the liability (AP). Explained differently, you want to convert (collect) your AR as quickly as possible and wait as long as possible to pay your AP.

Working Capital measures how well a company is able to convert product into cash, i.e., manage the cash conversion cycle. This is a fancy way of saying it is always better to collect now and pay later.

Why is this important?

Most of us have heard the adage “Cash is King”. Working Capital is a reflection of this adage.

The more Working Capital a company requires, the less cash the company is able to generate for shareholders or other investments.

Think of working capital like body fat, the less the better. World class hyper efficient companies will actually have a negative working capital, where they continually collect money before they deliver the product to the consumer (or at least have to pay their vendors and employees).

Unfortunately many in the collision repair business suffer from the opposite malady. Think of the company that is always bursting at the seams with work – yet never has the money to pay its bills or make payroll on time. Many assume this is a pricing or profitability issue when in reality it is a working capital management issue.

But I ensure you the largest and best managed companies in the collision industry do not face this issue. In fact quite the opposite.

Minimizing your working capital will allow your business to run more efficiently and perform at a higher level. It will allow you to grow more easily. It will allow you to invest with confidence. Should you decide to sell at some point your company will appear much more attractive to a potential acquirer.

There are a number of operational as well as financial aspects that need to be considered when managing working capital. And sometimes those considerations shift depending on your situation.

Yet even if you never plan to sell, merge, or take on an investor, effective working capital management is just the right thing to do. It makes you more attractive vendors, provides your business with increased flexibility, and generally creates a healthier business.

As always, if you have questions on how to improve your working capital management, or just questions in general, feel free to shoot me an email on the contact page.