Not much is more important than working capital in a retail business. Cash reserves are everything in retail. They’re what let you buy inventory, weather drier months, and pay unexpected expenses. Let’s explore what working capital is, why it’s so important to your retail business, and how you can go about acquiring and maintaining your working capital.
What is Working Capital?
So what is working capital exactly? Working capital is the sum total of a business’s assets, while net working capital is the company’s total assets minus its current liabilities. Generally speaking, a business should have an asset-liability ratio of 2:1 in order to be healthy.
That’s because a working capital ratio of two to one ratio allows for a sustainable and resilient business. The higher the ratio is, the more able the business is to weather a reduction in cash flow and the easier it is for the business to raise cash by selling assets at a reduced cost or even at a loss.
If your liabilities exceed your assets, resulting in low working capital, your business may be unsustainable and could shut down even if you have a positive cash flow. Your cash flow will at best reduce your liability but it will not be building a positive cash position that allows you to reliably pay the bills that keep your business running. It’s possible to keep a business open for a time in this position, but it is inherently unsustainable and will eventually fail when enough bills come due. Unless, of course, you figure out a way to build positive working capital.
Why is Working Capital Important to a Retail Business?
The most obvious reason for working capital in a retail business is inventory. In order to sell items and generate cash flow, you first need to buy them yourself. That puts an upfront cost to any retail business. While you can use the profits from positive cash flow to restock, that doesn’t help you get started and doesn’t protect against unforeseen circumstances.
Initial Retail Business Working Capital
In order to launch a successful retail business, you need to start out with healthy working capital. Kickstarting your cash flow requires a starting inventory, plus marketing and sales costs. If your initial working capital isn’t sufficient to purchase your inventory and pay your set costs for the foreseeable future, your business will never get off the ground.
This is why it is important to plan ahead before starting a retail business and make sure that you have the resources it will require to make the business a success. Lay aside enough for your first batch of inventory plus your first year or six months of rent, utilities, and employee wages, or personal living expenses if you’re going to run the store yourself. Any additional capital will give your business added security.
If you don’t have the personal resources or investor backing to build this initial working capital, it’s worth opening a working capital line of credit or taking on business capital loans. We’ll explore this process further in a later section.
Working Capital to Maintain a Retail Business
Working capital in a retail business isn’t just necessary to get the business started, it’s also invaluable in keeping it running. As you probably know, inconsistency is the way of life for a retail business. You have busy months and dry months, so current positive cash flow does not predict future cash flow or protect against future losses.
Working capital is the safety cushion that makes sure that your business stays afloat in times of reduced cash flow from either decreased income or increased expenses. It also allows you to build up your stock in advance of expected high volume months, market your company to drum up business and make improvements to your store.
How to Get Working Capital in Retail Business
So how do you build working capital in a retail business? Maintaining a positive cash flow can add to your working capital and eventually create a self-sustaining operating capital. But first, you need an upfront sum to kickstart your working capital or refill depleted cash reserves. Unless you have enough money to front the working capital yourself or can find investors to provide it for you, chances are that your best bet is to take out a working capital loan.
Business Capital Loans
There are a few different types of working capital loans. These loans differ from traditional business loans in that they are not used to buy a fixed business asset that is used as collateral against the debt. Instead, they offer companies the resources they need to cover a wide variety of expenses and grow the business.
The two main forms of business capital loans are fixed-term loans and lines of credit. Generally speaking, the best option is to take out a working capital line of credit. Fixed-term loans require you to take out a loan that is greater than your current needs to establish your working capital and requires you to pay it back in regular installments. This can hurt your ability to build a positive cash flow by creating a consistent drain on your resources in exchange for a large cash advance.
Lines of credit, on the other hand, allow you to access the safety net that a set working capital provides without having to take out more debt than you need. Instead of taking out the lump sum of your working capital in a fixed-term loan, you can take out a line of credit with the same cap. Then, you can draw upon the line of credit as needed but the lender holds onto the unused capital, reducing your costs.
How to Protect Your Working Capital
Once you have established your base working capital in a retail business, the next step is to keep it from shrinking and ideally to grow it. Basically, this entails minimizing the amount that you take from your cash reserves while maximizing the amount that you put into them by maintaining positive cash flow.
The first thing to do is to plan around expected expenses. Budget for your rent, utilities, employee wages, and any other fixed costs. Divide annual, quarterly, or irregular but consistent expenses such as maintaining or replacing equipment over the course of the year so you aren’t met by a pile of bills in a given month. These two strategies keep the bulk of your liabilities manageable so you can maintain your working capital.
The next thing you need to tackle is your inventory system. The best way to protect your working capital is to only buy inventory that you will sell within the timeframe of the invoice, so inventory pays for itself. If you can, negotiate longer dating for your invoices to give yourself a bigger window to sell the inventory. This will allow you to take advantage of the savings of buying in bulk without exposing yourself to having to pay for product you haven’t sold yet. If you can’t do that, try to buy from vendors who can ship items immediately so that you can buy inventory in smaller quantities without fear of running out of stock.
It’s also important to not let yesterday’s victory become tomorrow’s defeat. You should always stock for the month ahead, not the previous month. That way you won’t eat into your working capital by overstocking for a slow month because the month before was busy.
Finally, try to add to your working capital whenever possible. While it may be tempting to take a bigger payday when your cash flow increases, try putting the money back into your business by covering expenses that would otherwise come from your cash reserves or adding it to your reserves directly. That way you can pay off your loans more quickly and take full ownership over your working capital.
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