Working capital is essential to operating a successful business. There must be free flowing cash to pay the bills. Simply stated, CASH makes the economy function and credit is the great (cash) enhancer!
Buyers, sellers, business brokers and other professionals need to not only understand working capital, but know how to leverage it to close more deals.
Most accountants agree that the definition of working capital is current assets minus current liabilities. This is the acid test of financial analysts.
Business owners and managers know that the working capital available to them is the sum of the following:
- Cash on hand and in the bank.
- Customer accounts receivable to be collected soon, as in immediately
- Inventory that can be converted to saleable products, sold, converted to cash or customer accounts receivable in 30 days or less.
- Vendor accounts payable owed to suppliers of products and services sold to the company on “open” account. Typically with payment terms under 30 days and discounts offered for 10 day payment.
- Open bank lines of credit (LOC).
Business owners’ number one concern is running short of cash to meet their immediate obligations, such as rent to the landlord, payroll to employee and payroll taxes to the IRS.
Business brokers should know what makes up working capital and how to advise buyers and sellers to structure deals.
Working capital is:
- Cash, plus
- Customer accounts receivable, plus
- Inventory, plus
- Vendor accounts payable, EQUALS
- TOTAL WORKING CAPITAL
Business owners usually do not think about the impact of working capital on the buyer of their business or more bluntly, it’s not their problem. Learn to advise sellers that including customer accounts receivable, inventory and vendor accounts payable in the transaction. It will enhance the likelihood of a successful sale. Business brokers are well served to begin influencing the business owner early in the process to help close the gap on deals.
Explain to sellers that asset sales for businesses do not include the sale of cash, but maintaining adequate working capital in the business is essential for a buyer’s success. Inadequate working capital in the business makes it near impossible for most buyers to obtain financing to buy the business.
Inform buyers on working capital dynamics of the business. Try to determine if buyers have the financial clout to borrow more money than the amount required to get financed. Buyers need to understand that they should have other funding sources available in the event more working capital is needed after the transaction closes.
Customer accounts receivable is usually the first additional business asset the business owner/seller wants to exclude. Their position is that they have already earned this money.
Vendor accounts payable are another misunderstood item. This line item is unsecured debt owed to the vendor. By negotiating a similar credit granting practice with approved credit, the buyer is getting a “free loan” from the vendor and reduces the buyer’s obligation from personal funds or a lender. Simply put, debts assumed by a buyer is the same as cash paid to the seller by the buyer.
All parties are well served to have direct working capital discussions between buyer and seller with the business broker during site visits and prior to an offer.