The Structure Where +100% Sales Leads to Cash Shortage | Managing Without Understanding Working Capital is Dangerous: The 'Working Capital' Trap That Business Owners Don't Know
Companies that go bankrupt despite being profitable
The cause is simple:
they do not understand 'working capital'.
The more sales grow, the more cash decreases.
Business owners who do not know this structure will inevitably fail.
In this article, I will explain the structure of:
・Why sales growth causes cash flow deterioration
・The real indicators that banks are looking at
・The numbers you must watch to survive
I will explain these structurally.
--
1. What is working capital?
The working capital that financial institutions look at is
Current Assets - Current Liabilities
calculated as follows.
Current assets are
・Cash
・Accounts receivable
・Inventory
and so on.
What are current liabilities?
・Accounts payable
・Accrued expenses
・Short-term borrowings
and so on.
In other words,
Working capital is the funds necessary to keep the business running.
is.
If sales increase,
・Accounts receivable increase
・Inventory increases
In other words,
working capital also increases.
Companies that do not understand this
find their cash flow becoming tighter
as their sales grow.
--
2. Why cash decreases as sales grow
This is where many business owners get confused.
Sales are growing.
The number of customers is increasing.
Yet,
for some reason, cash flow is becoming difficult.
The reason is simple.
It is because the more sales increase,
the more working capital is required.
For example,
when sales increase:
・Accounts receivable increase.
・Inventory increases.
In other words,
funds are needed before cash is collected.
Furthermore,
fixed costs also increase.
・Hiring more people.
・Increasing advertising.
・Strengthening development.
Sales are growing.
However,
cash is flowing out.
Within this structure,
the more sales increase,
the more cash decreases.
The trap many startups fall into
The P&L looks good.
Sales are growing.
However,
the bank account balance continues to drop.
A company
does not die from a lack of profit.
A company dies
when it runs out of cash.
--
3. Information Not Visible on the Books
However, there is
another important issue here.
There is
information that is not visible on the books.
That is
the relationship between inventory and fixed assets
.
For example, let's consider a rental business.
Products for rent are
usually
recorded as fixed assets
.
And
depreciation
is used to expense them over time.
This is as I wrote in a previous article.
--
4. Fixed Assets and Inventory
But what if
this asset
were treated as inventory
?
Fixed assets are
not current assets.
However,
inventory becomes a current asset
.
In other words,
if you treat fixed assets as inventory,
current assets will increase.
And
Working Capital = Current Assets - Current Liabilities
will also look larger.
In short,
just by changing how the books look,
the required working capital
can also appear larger.
--
5. Books and Cash are Different
Of course,
this is merely a matter of accounting treatment,
and it is not a question of illegality.
However, what is important here is
that how the books look
and the reality of cash
are different.
What the bank is looking at
is not the books.
It is the structure
in which cash flows.
No matter how large current assets may appear,
if cash does not circulate,
the company will come to a halt.
--
6. The Numbers Business Owners Should Watch
That is precisely why
there are numbers that business owners should always keep track of.
That is
working capital.
.
Working capital is
the cash that is
constantly tied up for a company to run its business.
In other words,
it is the fuel
needed to keep the business moving.
Companies that do not understand this figure
find their cash flow becoming more difficult
as their sales grow.
--
7. Indicators of Survival
In startup management,
・Sales
・Profit
・KPIs
are often discussed.
However,
what determines whether a company survives
is something much simpler.
Is the cash circulating?
One of the criteria for that judgment
is working capital.
Always keep track of working capitaland secure it.
That is
one of the most fundamental indicatorsfor maintaining a company's survival.
--
Conclusion
Startup management is not
the job of generating sales.
It is not the job of generating profit either.
It is the job of creating a structure where cash flows
is.
Cash, not the ledger
And
Working capital
Only when you understand these two
will your company
acquire a structure that does not die.
There are only three things an executive should look at every month
・Cash balance, not sales
・Fluctuations in working capital
・The gap between collection cycles and payment cycles
When these three collapse,
the company begins to die.