“We were always focused on our profit and loss statement. But cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.” – Michael Dell, founder and CEO, Dell Technologies
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The academic definition of working capital is a simple one: take current assets and subtract current liabilities; the difference provides a firm’s working capital. However, such simplicity disguises the importance of the calculation. Few young, first-time, and inexperienced entrepreneurs (and even seasoned operators) seem to truly internalize the influence and importance of working capital on free cash flows in a business.
In any business (but especially small ones), working capital can make or break the organization’s financial health. Attractive working capital dynamics can transform a seemingly meager bottom line into hearty free cash flows. Conversely, weak working capital dynamics in a growing company can – despite an impressive bottom line on the income statement – create a perpetually cash-strapped situation. Some companies with particularly large working capital demands may even find that high revenue growth – a metric exalted by many – can lead to declining free cash flows. Business operators need to beware. Working capital is the blood and oxygen that sustains a business. Without adequate levels, the business perishes, regardless of how good everything else looks.
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