39
franchise.co.nz – PUTTING PEOPLE IN BUSINESS
eople will tell you a lack of working capital is the most common
reason that businesses fail. Buying a franchise and trying to run it
without sufficient working capital is like going on a road trip without
enough fuel to reach the next petrol station. So, what exactly is working
capital, and how do you work out what you need?
What is working capital?
When you purchase a franchised business, you’ll first consider the initial
capital outlay you’ll need for items such as building fit-out, vehicles,
signage, equipment, uniforms and, of course, the initial fee to use
the franchise’s system and brand. This is the cost of getting into the
business – but it’s not the money you’ll need to run the business.
Working capital is the money that you will need on a day-to-day basis to
buy supplies or stock, pay your power bill, meet staff wages and all the
other things that a business has to do.
When you first open your doors, you are likely to have more money going
out than coming in, so you need to have enough funds available to make
up the difference. As your business grows, you may have more money
coming in than going out, but you’ll still need working capital because
you’ll need to buy more supplies or stock. In fact, if your business is
growing fast, you’ll need more working capital than before to fund the
time difference.
How much do you need?
The amount you need depends on various factors. For example, is your
business premises-based or mobile? Do you mainly make cash sales,
or give customers time to pay? Is it a start-up or have you taken over an
existing business?
In a typical food and beverage business, customers pay on the spot,
whereas the wages and suppliers are usually paid weekly. This type of
business is often called a cash business, which is defined as having no
debtors (customers who pay on credit terms) and little, or no, stock.
Contrast this to a service business such as a building company, which
pays its workers weekly, while providing credit to customers who may
take weeks to pay. Or a retail business, which holds stock on shelves,
pays rent and wages, yet its customers pay on invoice.
Here’s a diagram that shows how the cash outlaid to deliver the product
or service is finally recovered. As the examples given above show, the
amount of time it takes to complete the cycle will vary. But whether it’s
20 days or 90 days, the principle is the same.
Cash introduced at the start of the cycle is the working capital. Once a
full trading cycle has occurred, the cash will be replenished when the
product or service is paid for.
Stock purchased - To make sales, you need something to sell. Stock
needs to be purchased, and suppliers paid, often before you start to
trade. Lead times for restocking and minimum buying quantities should
be considered. Over stocking or slow-moving stock lines can lock up
cash and impact working capital requirements.
Wages paid - Staffing levels vary enormously, and you need to pay
everyone on time, every time.
Product or service created - Capital required varies according to each
business. With product businesses, you need stock or ingredients. For
service businesses, you may hold basic parts, pay maintenance costs etc.
Customers invoiced - Do customers pay on the spot or, say, on the 20th of
the month? How many pay even later? In tighter economic times, slow
paying customers can put pressure on working capital of a business, and
this can have a domino effect.
Remember, it’s not until money has come in from customers that you
have the cash to fund the next cycle. So, if your new restaurant is
fantastically successful, you will need more working capital to fund the
purchases for the next cycle, not less. You might be profitable, but profit
is not the same thing as cashflow. Even a profitable business can fail if
there is insufficient cash to fund its growth.
Finding the money
When you have established the working capital you require, how do you
source it? Here are some common techniques:
1. The owner introducing more cash to the business.
2. Borrowing from banks via a loan, overdraft etc.
3. Using cash generated from profits.
4. Releasing funds locked-up in the trading cycle, eg. money tied up in
stock or debtors.
Taking advice
When you buy a franchise, you need to find the money to fund its
ongoing operation and growth, too. This requires planning. We strongly
recommend every franchisee prepares not just a budget but a cashflow
forecast to determine how much working capital they require, and when.
Preparing these is a specialised skill. Engaging a chartered accountant
with franchise experience
can provide you with
insights that are unique to
your business.
At the end of the day, it is
up to you to make sure
you have enough fuel in
the tank to complete
your journey to
business success.
Running a Franchise
WORKING
CAPITAL -
THE FUEL IN
YOUR TANK
Philip Morrison of Franchise
Accountants explains what
you need to get your business
started and keep it going.
Franchise Accountants
www.franchiseaccountants.co.nz
Contact
Philip Morrison
0800 555 8020
021 22 99 657
pmorrison@franchiseaccountants.co.nz
Advertiser Info