All startups need a strong eye on their day to day working capital to make smarter decisions and better financial modeling. Strong, positive working capital is a key indicator of the health of your business.
Simply put, working capital is the measurement of the difference between what your company makes and what your company owes. If you are carrying more debt than you have liquid assets, you have negative working capital.
The Working Capital Formula: Net Working Capital = Current Assets – Current Liabilities.
Keeping an eye on your working capital requires that your accounting method has a full view of impending cash and both long term and short term liabilities at any given time.
Tips For Maintaining Positive Working Capital
1. Switch to Accrual Basis Accounting
Your first step towards maintaining a healthy view of your financial outlook is switching from cash method accounting to the accrual method.
Accrual accounting is a double-entry method of accounting where the number of debits must
equal the number of credits. This approach ensures that the basic accounting equation of net income (assets = liabilities + equity) is always in balance. This system allows you to factor in the impact of business loans and other accrued expenses, while also factoring in impending cash flow to your business from clients or investors. The other significant difference is that you will be paying taxes on money still owed.
Your credits and debts will be reflected in your various financial statements (balance sheets, income statements, cash flow statement, budgets, etc.), and your accounting checklist should include, at a minimum, the following:
Accrued Employee Vacation
2. Keep an Eye on Your Net Working Capital Ratio
In the early stages of a business or during a period of rapid growth, you’ll likely be taking on a lot of debt.
You can calculate your working capital ratio by dividing your current assets by your current liabilities. A working capital ratio between 1.2 and 2 is typical of a healthy business with enough assets to fully secure immediate debt. Many investors will take the measure of a company by looking at this ratio.
3. Manage Your Expenses and Debt Payments
A strong startup accountant will always have a view of operating costs, sales, overhead, assets, liabilities, inventory, and the cost of increasing human capital. By keeping a view on recurring expenses and projected income, you’ll be able to create rolling financial projections and set spending limits on low-priority items.
When you’re looking to trim the fat, it will be essential to have all of these items prioritized, so when it’s time to go to the chopping block, you already have contenders lined up.
As for your debts, incurring late fees or penalties can quickly become a large problem. By limiting how much debt you take on and ensure you always pay on time, you will be in a better position.
4. Incentivize Payments (And Penalize Late Payments)
Just like your business is working to maintain its capital, others are too, and it may be that your customers are waiting till the last possible second to pay you – or beyond. One way to help stay liquid is to incentivize on time or early payments. For example, you can give a discount to customers who use automatic billing or pay for an entire year of services upfront.
On the other hand, you should also add a late fee policy to your customer agreements, ensuring they are fully on board with this during onboarding.
5. Automate Processes and Business Reporting
Automating business processes such as accounts payable or receivable, customer invoicing, inventory management, etc. helps you save on labor costs and prevents costly errors in your data. It also makes it easier to keep on top of your cash inflow and outflow.
This transition towards automation also allows for data-driven business management utilizing business intelligence dashboards. These tools will give you an early warning sign if your working capital is in peril, and identify the responsible factors quickly so you can make all necessary business decisions.
6. Bring in a Tax Specialist
A tax strategy should be near the top of your list as your startup grows to maintain strong working capital. While taxes are always inevitable, the way you structure your business and key processes can reduce what you owe. You also need to be aware of some of the lesser-known tax deductions that can also make a big difference when tax season rolls around.
Considerations for a startup’s tax strategy include:
- How you structure your business
- Properly documenting all income and deductible expenses
- Manage your payroll tax
- Carryover net operating losses
- Apply for the R&D Tax Credit
Be sure to also read our full guide for startups on building a better tax strategy.
Want Expert Help Managing Your Working Capital?
It is always preferable to have an expert in your corner when you aren’t able to give your full attention to finances.
In terms of your growth cycle, you should look to bring in an accountant when your business model and revenue model are more complex and require more than merely classifying your credit card transactions and banking transactions.
Greenough Group’s startup accounting services and tax specialists are highly sought by both small businesses and rapid-growth tech startups alike. Their involvement in your business is scalable to remain cost-effective, and their hourly commitment can grow alongside your business.
GCG is the preferred accounting services for startups firm of executive Tom Rowley, who has utilized GCG’s services in several of his ventures: “I’ve brought GCG into my last four startups. Getting finance running smoothly, as quickly as possible, allows me to focus on building the business. Hiring GCG is one of the first things I do.”
Our reputation for accuracy, senior attention, and exceptional client service has made us one of the financial community’s most highly recommended back-office services firms. Contact us today for a free consultation and learn how we can help you focus on growing your business.