If Working Capital is the life-blood of a business, then the Assets and Liabilities are the working parts.
The machinery and equipment needed to operate your business, and the ways of funding that equipment, are called the assets and liabilities of the company.
Not all businesses use the same equipment, but whatever they do use falls into one of the two categories above.
A newspaper printing company may use a printing press that takes up a whole factory, while a small commercial printer may only use one or two lithographic machines.
A large company might raise capital through the sale of shares and bank loans, while a smaller business may raise a loan from a family member or make use of their savings.
Assets are items that have value, belong to the company and will provide economic benefit in the long term. Liabilities also have a value, but the company owes that value to someone else.
The amount by which your assets exceed your liabilities, indicates the solvency of your business.
Examples of assets are: company-owned vehicles, cash, stock, and equipment.
Examples of Liabilities are: Bank loans, Equity, and Tax debt.
Let’s come to grips with some of the tricky terms:
Assets can be divided into fixed and current assets.
· Fixed assets are items that are intended for long-term ownership, and take longer to convert into cash, i.e. property, vehicles and machinery.
· Current assets are items that by nature have shorter lifespans and are used in the daily funding and operating of the business, i.e. debtors, stock and cash. These items are also more easily converted into cash.
Liabilities are divided into three categories; equity, long-term liabilities and short-term liabilities.
· Explained very simply, equity are the funds invested by the owners in the form of shareholding and loans to the company. These do not normally have fixed repayment terms attached to them.
· Long-term liabilities are by nature used to fund the fixed assets, and are generally loans repayable over periods of more than one year. These would include bonds on properties, higher purchase (HP) agreements to finance machines and equipment, and fixed term loans.
· Current liabilities are debts that need to be repaid in the short-term, usually a period less than a year. These include creditors and bank overdrafts.
Work that ‘working capital’
In The Springboard Academy’s previous blog post about cash flow , we referred to working capital, which can be calculated in the following way:
(Stock + debtors + bank + cash) – (Creditors – bank overdraft)
Current assets – Current liabilities.
Working capital is also an indicator of the liquidity of the business, and its ability to continue trading.
In a nutshell, the lower the amount of working capital you have, the more difficult it is to continue trading. There are few exceptions.
In determining the liquidity of your business, you must also analyse your stock and debtors. If your stock is obsolete, then you will not be able to sell it, and its value is diminished.
If your debtors are finding it difficult to pay you, you may not have enough funds to pay your creditors and buy stock, and so may not be able to continue trading.
To be in a position to effectively manage your working capital and cash flow, you need to keep accurate and up-to-date records. Invest in a good accounting system and / or engage the services of an efficient accountant. Good admin processes are essential.
Do not hesitate to contact The Springboard Academy for assistance or advice in this regard.
**Take a look at our previous blog posts about the items you will find in a company’s financial statements. And be sure not to miss next week’s post about income statements, balance sheets and cash flow.
Until then, feed your passion!