Finance & accounting professionals have a different view of the business world than most entrepreneurs. There are many reasons why this is so, but primarily it’s because they speak different languages. Both tend to think the other is the blame for their frequent inability to communicate with each other about a business problem.
The communication problem begins with their views towards accounting standards & protocols; the two sides are not objectively partnered in the accounting control process.
“Working capital is one of those issues where frequently neither party has clarity on what it is, how to calculate it and what to do with the information.”
Many finance and accounting professionals will become defensive reading that statement because they have been taught the definition and can clearly recite the definition which explains quite simply that “working capital is current assets minus current liabilities.”
How hard is that to understand they ask, usually under their breath? The entrepreneur will normally hear it and understand it but may simply set it aside as it is part of a meaningless conversation. They frequently struggle to figure out how it relates to them dealing with an immediate business issue that may or may not be directly related to a current working capital problem. The outcome often becomes the entrepreneur concluding that the help they need isn’t available from the accounting & finance professional and the professional deciding the entrepreneur doesn’t want or need his or her help.
To an entrepreneur, doing the math on a months old Balance Sheet hardly seems relevant, particularly if the statement indicates no working capital problem seems to exist or offers no help if it does.
The problem is actually more than language and definitions alone. The bigger problem is the pace of business activity is faster, with more substantive changes and nuances taking place than entrepreneurial accounting systems and protocols have been designed to capture and communicate so that the decision maker can act, react or be advised in a timely manner. Both parties have engaged in a compromised relationship.
“Working capital is not always current assets minus liabilities!” In today’s entrepreneurial world the GAAP driven protocols are rarely in place for entrepreneurial businesses. Financial Statements and Balance Sheets are being created with little regard to accurate conclusions and usefulness of the financial statements being created and usually being updated only to become a support mechanism for Tax Return preparation.
The frequency of this activity taking place is increasing as computers are able to keep up with activity but the understanding and best classification of the data capture is frequently flawed resulting in users getting financial statements faster but presenting the information in a way that is no more accurate or helpful. Entrepreneurial decision making involving advisors who wrongly assume that a concept like working capital is easy to discern.
The problem that needs to be addressed. The traditional definition of working capital is a simple mathematical calculation, is not always useful but working capital understanding is none the less a critical part of business success and it needs to be captured and presented frequently in real time in order to be properly addressed and managed.
Traditional Working Capital Components
Cash: Balance Sheets do not measure the velocity or the volatility of cash which can result in significantly different cash levels and needs between balance sheet positions, sometimes daily. What the cash position was on Dec. 31 may not have relevance to decisions being made on January 10th.
Inventory: Unlike cash, all inventory is not equal. Some inventory items are slower moving than others. Some immediate inventory needs may not be met. Like cash, inventory velocity and volatility matter. Supply timelines, product sales mix, advertising plans and other variables affect whether or not inventory levels are good, bad or indifferent and can be extremely misleading in terms of working capital health.
Accounts Receivables: Billing and collections timelines can vary by client as well as by platforms and many other issues. A receivable that was billed late and at the end of the defined collection timeline is often treated equally as a timely billed invoice early in the collection cycle but both affect working capital differently. Percentages of cash receipts versus billed receipts going forward can dramatically affect working capital management.
Accounts Payable: Much like receivables, payables have timing issues. Similar to receivables all transactions may or may not be accurately reflected as current in some clearly defined parameter. Current Accounts Payable positions may be limited, unavailable in the future or have some other quality not defined or noted on a Balance Sheet Statement.
The only logical conclusion that can be drawn is that working capital is unlikely to be properly measured or understood. Entrepreneurs are frequently unable to manage cash flows even if they have access to timely financial statements which is frequently not the case.
Business decision making is hampered by bad information and measures to address it are frequently too little, too late. Small business failure is often the inevitable result, even when it has a better mousetrap. MBA Tampa Bay- All rights reserved.