Most business owners want to grow the size of their business.  Actually, if we really dig in to that statement it might be better to say that most business owners want to grow the value of their business.  Bluntly, we all want our businesses to be worth more.

So the default approach is to grow it.  Entirely logical. The next logical deduction that many business owners make from this is that they need more capital to grow their business. And so they start down the slippery slope of raising more debt or raising more equity to fund that growth.

Which may or may not make sense…

Now if you are building a product the chances are you need plenty of capital and you’ll need investors, but the majority of us are actually building service businesses that serve a need in the public.

We need working capital.  We need money to fund the ‘gap’ between the time when our customers pay us and when we pay our suppliers.  If you read a previous post on the levers of business you will hopefully have realised that you can control that gap to a certain degree.

What I want to do in this article is help you realise that the lower you can make the working capital requirements of your business the more you can increase the size of it, without needing outside capital.

So, here is the formula for working capital:

Working Capital = Accounts Receivable + Inventory – Accounts Payable

I’m going to give you another formula now that we will come back to:

Working Capital % (WC%) = Working Capital / Annualised Revenue

So, with a bit of basic mathematics we can work out that we reduce WC% if we reduce Working Capital.  Let me give you an example on this.  Let’s say our Annualised Revenue (Turnover) is $10 Million and our Working Capital is $1 Million.

WC% = $1M / $10M = 10%

Lets say we wanted to grow our revenue next year to $11 Million, a $1 Million increase (10%).  The WC% formula says we would need an extra 10% in working capital or $100,000.  Where do we get it.  It either comes from internal reserves, debt or equity.

Now, consider an alternate scenario.  Lets say that our Working Capital was only $400K not $1 Million.  Our formula is now different:

WC% = $400K / $10M = 4%

So now, next year, we still want that increase in revenue of $1 Million.  Now the WC% formula says we need an extra 4% in working capital or $40,000. Wait! What!  Now we only need $40K vs $100K.  We can grow our business 2.5 times from the same revenue we could before!

We just need to control our working capital.  So how do we do that?

Working Capital = Accounts Receivable + Inventory – Accounts Payable

We need to look for ways to reduce our Accounts Receivable and Inventory Levels and increase our Accounts Payable.

In simple terms “collect faster” and “pay slower”. This is all about managing the expectations of our customers and our suppliers and building processes to manage that. Hopefully, you have just realised how important your finance team are! they manage these relationships and their effectiveness in doing their job will be critical in reducing the working capital you require to run your business and therefore how much funding you need to grow your business.