Working capital? Growth capital?

• What do the terms mean?
• Which do we need?
• What is the difference?
• Why should we care?

I have heard these questions over & over again from both consulting clients & training attendees; so here are the answers.

Working capital (WC) is the difference between your current assets and current liabilities. It is a measure of your liquidity; your ability to pay your current obligations (bills) when due. The higher your working capital, measured in currency, the more comfortable your suppliers & lenders are.

It is similar to the Current ratio which is current assets MINUS current liabilities. The result is a proportion rather than currency amount.

Growth capital (GC), on the other hand, is the amount of long-term debt & equity on your balance sheet financing your future growth.

WC is important in the short-term. GC is critical over the long-term. Both have to be managed properly for any organization to be financially stable.

WC is measured on the upper portion of the balance sheet. GC is calculated by looking at the lower portion.

WC focuses on cash flow to pay current liabilities. GC is repaid via profits.

You need to establish the levels of WC you choose to maintain. This is tactical. Minimize working capital allows you to reduce the level of current assets you need to carry yet increases the risk of you not being able to pay your bills when due. Maximizing WC reduces the risk of missing payments but locks up cash in illiquid assets like inventory & receivables.

The more GC you have the higher the profits you need to generate to repay lenders & shareholders. The lower your GC the less you can grow but the less risk of default.

The amount of GC you require is strategic: where do you want to take your organization & how much long-term debt & equity do you need to get there? Answer these questions & it is time to use the AFN (Additional Funding Needed) model. More on this on a later blog).

Understanding your working capital needs helps focus you on your short-term cash flows needs; sources & uses. While calculating your growth capital needs, over the long run, assists you in planning the necessary level of profits you need to generate to self-finance. Growth beyond what you existing capital can support requires AFN.
Contact Build It Backwards(SM) today and let our consulting services give your organization the foundation to succeed well into the future.

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