One of our favorite topics
We recently had the pleasure of working with some wonderful friends of Chenmark at the Yale School of Management to produce a note for students on the topic of working capital. The article, titled, On the Nature of Working Capital – Understanding its Mysteries and Complexities is the resource we wish we had back in 2015 when we started on our journey of small business acquisitions and operations.
What’s interesting to us is that in financial markets, a large positive working capital position can be viewed as a favorable attribute since it’s seen as an asset (people owe you, and you don’t owe anybody). Additionally, our business school discussions viewed the cash flow statement as a throw-away document, far inferior to the balance sheet or income statement.
However, we quickly learned that in a real operating business, having to pay your bills quickly (i.e., a low payables balance) whilst having lots of people owe you money (i.e., a large receivables balance) doesn’t really do you much good. As it turns out, you need actual cash — not IOU’s — to cover payroll. Understanding the working capital dynamics of a potential business acquisition, and how to improve those dynamics of a business you already own, are critical aspects of being a successful small business owner. A short excerpt from the article:
“There are no silver bullets in the realm of small business working capital management. No single action will cut your business’s working capital balance by half in one fell swoop. Instead of seeking home runs, operators must pursue singles. A focus on the numerous small things that affect working capital, along with a consistent dedication to instilling healthy cash management processes in your employees, will produce results. Working capital management is not sexy. MBA students entering high-powered consultancies are unlikely to advise clients on the topics discussed below. But in the small business arena, attention to such details creates attractive financial returns.”
As they say — revenue is vanity, profits are sanity, but cash is reality. Amen.
Have a great week,
Your Chenmark Team