BRB Rules

What is a Working Capital Cycle

by Brandon Wyson7 minutes / September 3, 2021

The Key Details of the Working Capital Cycle

In the sometimes-lengthy process of turning a product into capital, all businesses are subject to what is called the “working capital cycle” (WCC). The working capital cycle is the amount of time it takes for a business to pay off their liabilities, such as their suppliers, and then begin collecting all cash they receive from sales as profit within one operating cycle. A well-managed working capital cycle often reflects a well-managed business. Businesses with working capital cycles with too many operational stopgaps can lead to low liquidity and a less stable production line. Effectively managing your company’s working capital cycle can give massive insight into your own operations and can better inform your financial decision-making.

Elements of a Working Capital Cycle

A working capital cycle can be separated into three categories, often called Accounts Payable Days, Inventory Days, and Accounts Receivable Days:

Accounts Payable Days: A business purchases raw materials for manufacturing and has a certain number of days to pay suppliers. The number of days in which you must pay your suppliers are your “Accounts Payable Days.”

Inventory Days: A business sells that inventory made from those raw materials to customers over a certain number of days. However many days it takes to sell your inventory are your “Inventory Days.”

Accounts Receivable Days: A business receives payment from customers over a certain number of days via invoice or credit card. The number of days you must wait for invoices and credit charges to become capital are your “Accounts Receivable Days.”

The basis of a good working capital cycle is making sure accounts receivable and inventory days are few enough so you can still pay suppliers on time. A working capital cycle can also be written as the formula:

Inventory Days + Receivable Days – Payable Days = Working Capital Cycle

Positive Working Capital Cycle

In most working capital cycles there are more accounts payable days — the days where payments from clients come in — than inventory and receivable days. This can be due to invoices or credit card processing windows that can take up to several weeks to become capital. Working capital cycles where payable days outnumber the sum of inventory days and receivable days are called positive working capital cycles.

Positive Working Capital Cycle Example: A CD manufacturing company takes 80 days to sell their available inventory during an operations cycle and then takes 45 days for credit card payments and invoices to become capital. The company also has 45 days to pay their suppliers for the raw materials, so their working capital cycle takes 80 days and is positive.

80 Inventory Days + 45 Accounts Receivable Days – 45 Accounts Payable Days = 80-Day Working Capital Cycle

Negative Working Capital Cycle

Despite its name, negative working capital cycles are often anything but a negative impact on a business’s operations. If your business has no gap between when inventory is sold in exchange for hard capital, they very likely would run a negative working capital cycle. The most traditional example of negative working capital cycle businesses are those that only accept cash. A business that deals solely in cash and has no invoices would have a zero Accounts Receivable Days meaning it is possible Accounts Payable Days may be greater than Inventory Days, leading to a negative working capital cycle.

Negative Working Capital Cycle Example: A local farmers market takes 30 days to sell all of their available inventory during one operations cycle. The farmers market only accepts cash and has no invoices. Since the farmers market has all capital on-hand at the point of sale, they have 0 Accounts Receivable Days. The farmers market takes 45 days to pay for raw materials and liabilities, meaning their working capital cycle takes -15 days.

30 Inventory Days + 0 Accounts Receivable Days – 45 Accounts Payable Days = -15-Day Working Capital Cycle

Improving Working Capital with Tactical Financing

One of the most frustrating parts of business operations is waiting for invoices to cash after making a sale. The 30, 60 or even 120 days necessary for invoices to become capital will take a massive toll on a company’s working capital cycle. That number of days is a business’s “Accounts Receivable Days” and by shortening the amount of time an invoice is in limbo, a business can massively improve their working capital cycle.

Invoice factoring is an agreement between a business and lender where the business sells unpaid invoices to a lender who then pays approximately 95% of the invoice’s value up front. In most invoice factoring agreements, it is then up to the lender to collect on the original invoice. When the client’s invoice eventually clears, the lender, or factor, will send a final percentage of the invoice to the business while usually keeping a 3% fee for the transaction.

By expediting the time an invoice takes to become capital, a business can massively increase their cash flow and in turn improve their working capital cycle. There are, however, counterexamples where an invoice factoring agreement may extend a working capital cycle. If an invoice factoring agreement allows for business recourse, then the business, not the lender, is responsible for invoices that go unpaid. This can also be the case if a factoring company is unable to collect, or has a difficult time collecting on an invoice. In these cases, it could be a while until you get that last percent from your invoices. If you would like to learn more about invoice factoring and other business loan options, please see Kapitus’s comprehensive guide detailing the several working capital loans options for small businesses.

Shortening Your Working Capital Cycle

Without becoming a solely cash business there are several strategies to shortening a working capital cycle to increase cash flow.

Reevaluate Manufacturer Options: When was the last time your business checked your supplier’s competition? Depending on your business and operation cycles there are likely several optimizations to your business which could effectively reduce Inventory Days. Is it possible to buy your most frequently used materials in bulk? Have you considered working with emerging manufacturing hotspots like Malaysia or Indonesia? Sit down with your team and think creatively about how your business can take advantage of rising globalism and manufacturing options to keep inventory turnover and quality high. Keep an eye out for local manufacturing options alternatives as well.

Renegotiate Existing Deals: Most modern operation cycles require several cultivated relationships with manufacturers and liveries which should be regularly assessed to make sure your business is getting the best deal possible. When your business buys raw materials from a supplier, how long is your credit period? That credit period is the same as your business’s Accounts Payable Days and by expanding the number of days your business must pay back suppliers in, your working capital cycle will shorten as well.

Kick Up Accounts Receivables Collection: There are several other ways to speed up accounts receivables collection without invoice factoring or financing. By shortening the amount of time between a sale and when that sale becomes liquid your business’s cash flow and working capital cycle will both improve. Consider making an updated A/R Aging Report which consolidates all of company’s accounts receivables data into one place for easy consideration and optimization. Does your business offer payment plans for high-volume purchases? A great way to attract new clients and boost monthly receivables is to offer structured payment plans. Another strategy to maximize your business’s accounts receivables is to increase your client base.

Final Considerations and the Nature of the Working Capital Cycle

Barring very specific industries, having a positive working capital cycle is a good indicator that a business is financially sound. Regarding growth, however, it is often difficult for companies to expand when their operational cycles leave low liquidity and high asset value. This is why several businesses seek financing from banks or private lenders to cover working capital and in turn reinvest in their own operations.

There is no universally ‘good’ working capital cycle because every business’s operations cycle is different. If your business has several long-term invoices, invoice financing could be a great way to kick up your working capital cycle. If your slowdown is on the manufacturer’s side however, you will need to consider wholly different solutions.

If you would like to learn more about your business’s working capital cycle financing options, please get in touch with a Kapitus financing expert who can address your unique situation.

Brandon Wyson

Content Writer

Brandon Wyson is a professional writer, editor, and translator with more than eight years of experience across three continents. He became a full-time writer with Kapitus in 2021 after working as a local journalist for multiple publications in New York City and Boston. Before this, he worked as a translator for the Japanese entertainment industry. Today Brandon writes educational articles about small business interests.

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Tips on Starting, Funding a New Business

Operating Your Business

by Vince Calio11 minutes / August 20, 2021

Bubbles with business related images inside floating above a bird view of the city.

Small businesses are being created now more than ever, thanks to people being laid off or furloughed during the COVID-19 pandemic and the advent of online tools aimed at helping budding entrepreneurs. In April 2021, roughly 500,000 people in the U.S. applied for new business applications, compared to just 300,000 in the same month of 2020, according to the Bureau of Labor Statistics.

While the current climate may make the decision to start your own business easier than ever before, it certainly doesn’t mean that starting a new business is easy. While creating your small business from scratch does start with a dream, a great idea and some funding, you’ll probably also need online training, business acumen and an understanding of some basic financial and marketing principles to get going.

Mapping Out Your Business

Whether you are launching a construction business, retail store, business services firm or an eCommerce site, before you even think about funding, you’ll need to produce a business plan.

A business plan is a specific outline of your business, what it will entail and how it will make money. If you plan to seek initial investors for your business, be it angel or venture cap investors or through crowdsourcing, you’re going to need one.

Source: Growthink

There are cost-effective online tools out there that can provide you with a template for a presentable business plan, such as this one from Growthink, that can make it easy for you – all you have to do is plug in the text and the program will do the rest for you. The basic ingredients of a plan for a new business are:

Executive Summary

The executive summary should clearly tell the reader what you want to accomplish as a business, and why your business is special. This is often referred to as a mission statement and is extremely important to potential investors. All too often, this is buried in the middle of the business plan but needs to be stated upfront.

Business Description

The business description should include a clear description of your industry, as well as the products or services you are seeking to sell within it. This is your chance to describe why your product or service stands out in the industry and why you think customers will choose it over your competitors.

Marketing Strategy

This part of the business plan requires a meticulous analysis of the market you are trying to sell your product in, and who you want to sell your product or services to. As an entrepreneur, you need to be familiar with all aspects of the market you’re looking to sell in, as well as carefully define your target market so that your company can be positioned to garner its share of sales.

Competitive Analysis

Present a description of what your competitors offer, what their strengths and weaknesses are, and how big the market is in which you are trying to sell. Then, clearly explain what gives your business a competitive advantage. Put simply, why do you think consumers will choose your products or services over your competitors?

Design and Development Plan

The purpose of a design and development plan is to provide a description of the design of your products or services, chart their development within the context of production, marketing and the company itself, and create a development budget that will enable your company to reach its goals.

Operations and Management Plan

This plan describes how your business will function on a continuing basis. Who, if anyone, is going to be in charge besides yourself? Where will your business function and what kind of equipment and inventory will you need? Who will you need to hire and for what functions?

Put simply, the plan will clearly explain the various responsibilities of your management team (if you plan to have one), the tasks assigned to each person in your company, as well as the capital and expense requirements related to the operations of the business.

If the only employee will be you, you need to clearly spell out what kind of compensation you will need for yourself, as well as the equipment, supplies and space you will need to make your business operate smoothly.

Business Basics

In planning out a new business, you need to learn basic business terms and why they’re important. There are online courses (and many of them are free!) to teach you the basics of managing a business, such as what sales and profit margins are, customer retention and conversion, etc.

In order to successfully launch your business, here are some basic business terms you should familiarize yourself with right off the bat:

Sales Margin

Also known as contribution margin, this metric basically determines what you should be charging for your products or services in order to be profitable. It is the amount of money you charge for your product minus the cost associated with producing your product or service. Those costs include manufacturing costs, advertising/marketing and salaries.

Customer Acquisition Cost

This metric helps determine what each sale costs. Simply add up the cost of marketing and sales — including salaries and overhead — and divide by the number of customers you land during a specific time frame.

Customer Retention Rate

Customer retention rate is a key metric that essentially tells you if your customers are happy, and will help you determine how quickly you can grow your business. It measures what percentage of your customers have kept coming back over a period of time, and can be calculated over a weekly, monthly or annual basis, depending on your preference.

Customer Conversion Rate

This metric basically tells you whether your marketing and sales efforts are paying off. It is simply the percentage of people who walk into your business or visit your website who end up becoming customers. If the conversion rate is low, you may want to change the way you are marketing or advertising your business. You may want to offer more discounts on your website if your conversion rate is low, for example.

Revenue Percentages

If your small business is like most, you probably have more than one source of revenue. Where your revenue is coming from will tell you about shifting trends in your market and what consumers are spending money on.

For example, if you run a small contracting business, you may get revenue from customers who want to build new homes and revenue from customers who want to renovate their homes. If you notice that, suddenly, many more customers are interested in home renovation rather than new home building, you may want to change your marketing efforts accordingly.

Build a Website

Whether you’re a doctor or a plumber, it is virtually impossible today to run your business without having an online presence. When consumers search for your services, the first place they will search is the internet.

Having an online presence means that potential customers can easily find you via a web search, know what products or services you offer, and what makes you unique. You can even set up your website to make direct sales.

Building your own website does not have to be costly, as there are plenty of do-it-yourself website builders such as Wix and SQUARESPACE that can make it easy. In a previous article, Kapitus offered a step-by-step guide to building your own site.

Potential Funding Sources

When you’re looking to start a business, traditional and alternative small business lending sources are probably not an option, since most require years in business. There are funding sources available to you, however, if your personal savings and help from friends and family members are not enough to start your own business:

Angel Investors

This option is pretty much what the hit show “Shark Tank” is about. Angel investors are individuals who are willing to invest in start-ups or early stage companies, typically between $25,000 to $100,000, in exchange for a piece of ownership. Their hope is that their investments will pay off big when your company either goes public or when your company becomes big enough so that you can comfortably buy out their pieces of ownership for a hefty sum more than the amount that they originally invested.

Source: Angel List

Angel investors are often successful entrepreneurs themselves and can offer mentorship and business advice, and typically want to see a strong business plan as well as your plans for growth before they invest. You can find angel investors from other entrepreneurs, or search online through sites such as Angel List.

Crowdfunding

Crowdfunding is becoming one of the most popular ways to garner funds for startup businesses. It is the practice of raising funds through popular crowdfunding websites.

Setting up a crowdfunding campaign is relatively easy. In most cases, all it takes is setting up a profile on a crowdfunding site, describing your company and its business, and the amount of money you are seeking to raise. In order to attract investors, your business plan and products must seem compelling and differentiating.

One of the best features of a typical crowdfunding plan is that you usually don’t have to give up pieces of ownership in your business, as people who are interested in investing typically do so in exchange for some kind of reward from your business, such as a discount based on the amount donated, or some form of profit sharing in your business.

Equity crowdfunding, however, is when you are selling stock or some other interest in your company in exchange for cash, and requires compliance with federal and state securities laws. In this form of crowdfunding, you should consult with an investment attorney.

Crowdfunding sites usually charge a fee to list your campaign, which will either be a processing fee or a percentage of the funds raised. Some of the most popular sites include Kickstarter, Indiegogo, Crowd Supply, Crowdfunder and SeedInvest.

Grants

There are several private grants available through application for startup and small businesses that could reward you with $10,000 to $150,000 in startup cash, especially if you are launching a woman- or minority-owned business. Additionally, there are some grants offered through the U.S. Small Business Administration. Some of these grants usually require a business to be community-related or involve mentorship of some kind, so be sure to carefully examine the requirements before applying.

Small Business Credit Cards

Since traditional and alternative business loans are not typically available for startup businesses, you may want to apply for a business credit card. These types of cards often require a strong personal credit score – not years in business – so they may be a good alternative funding source. Like with any credit card, interest is only charged on the amount borrowed, and these cards often come with perks such as cash back rewards, airline mileage points and discounts with selected retailers.

In the past year, a number of credit card issuers have offered cards that specifically focus on the small business market and do not require personal guarantees, which means use of the card will not impact your personal credit score. One example is Brex, which offers a small business card for early-stage technology companies with professional funding. The credit limits may be substantially higher than traditional credit cards, and they often provide valuable rewards.

Venture Capital

Of course, VC funding is usually thought of first as a funding source for startup companies, but they often have the most stringent requirements. VC managers typically want to see strong business plans, and often require seats on company boards, right of first refusal, anti-dilution protection and high ownership stakes. It is often difficult to obtain VC funding as most fund managers are inundated with funding requests and often only accept pitches through referrals from trusted sources, such as other successful startups and successful entrepreneurs.

Several rounds of funding are often involved, and most VC fund managers are seeking highly profitable exit strategies, such as an IPO or an acquisition, even though most startup businesses do not have any such plans on their horizons. If your startup business does have grand plans of becoming the next Amazon or Microsoft, then VC funding may be for you.

Starting your own business may be a complex, exhausting task that will require hard work and long hours, but in the end, the thought of being your own boss, setting your own hours and not having limits on your compensation to support you and your family may be worth it if you have a dream and a great idea.

Vince Calio

Content Writer

Vince Calio has been a writer for Kapitus since 2021. Before that, he spent three years operating a dry-cleaning store in Rahway, NJ that he inherited before selling the business, so he’s familiar with the challenges of operating a small business. Prior to that, Vince spent 14 years as both a financial journalist and content writer, most notably with Institutional Investor News and Crain Communications.

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How Body Shops Can Increase Profit Margins

Industry Challenges

by Brandon Wyson6 minutes / August 12, 2021

KEY TAKEAWAYS

Body shops can improve efficiency and customer satisfaction by embracing digital services and software solutions, such as digital multi-point inspections and management software, ultimately contributing to increased profit margins.
To maximize profit margins, Body shops should optimize labor costs by investing In experienced and efficient staff, offering competitive pay rates, and providing hands-on training to enhance productivity.
High customer retention is essential for body shops. Implement clear communication flows, referral incentives, and proactive scheduling of regular services like oil changes to keep existing body shop clients returning.

Body shops and the commercial auto repair industry at large pull in billions annually but often run with staggering operational costs from labor, parts, and general overhead. A body shop’s ability to keep revenue up is a means of survival but healthy profit margins are the basis of growth. To run a successful body shop, owners must keep a close eye on the several dozen avenues in which money both comes in and out of their shop. This article is a collection of tactics for body shop owners to maximize their profit margins without sacrificing quality and service.

How to Take Labor Margins and Staff Management into Account

While parts and facility costs will affect a body shop’s profit margins, staff and labor costs are just as important — if not more so. Having high-quality and efficient staff is the most concrete way to increase profit margins as experienced mechanics and technicians are likely to complete jobs faster and with fewer errors. Be certain that your shop’s pay rates are competitive and attractive to experienced workers and reassess your shop’s training structure to be more hands-on. Find out if your state offers subsidized training for auto workers as you may be able to send your staff for specialized training at a reduced cost; some vendors and suppliers are known to offer similar services. Get a general idea how long common procedures like coolant flushes or even more intensive repairs take your staff and use that information to price your services.

Instead of focusing on products and parts, remember that the knowledgeability and skill level of your staff is the basis of a good repair. According to Body Shop Business, labor profit margins for body shops often range between 50% and 65% while margins on parts go from 20% to 28%. Investing in good labor and maintaining a happy, productive staff is one of the best ways to put a body shop in the direction of better profit margins.

Improve Your Retention Rate

A trend report on customer retention from Invesp found that while businesses have about a 20% chance of pulling in a new customer, they have a 60% to 70% chance of bringing back a repeat customer. This is especially true for body shops as vehicle owners should never be a one-time sale. Cars require regular maintenance, so body shops ought to be certain they are homing in on customers that are already in their shop just as much as potential new sales. There are several key strategies to keeping your current customers engaged and willing to return for future services.

Candid and Clear Communication – Be certain that your staff regularly communicates with clients during a job. Make sure that your shop’s training and onboarding procedures are specific about keeping customers in the loop and being transparent about all steps in a repair. It’s also important to continually assess your upselling practices – making sure not to upsell them unnecessarily. Defeat the long-standing myth that independent body shops nickel-and-dime their customers by being candid and explaining why each step of a procedure is necessary.

Testimonials and Referral Incentives – Your existing customers have the potential to be your body shop’s best advocate and marketing tool. Consider offering discounts on basic services like oil changes or coolant flushes in exchange for customer referrals.

As your shop grows, it pays to be on top of your online reviews and to establish processes that help you solicit and respond to them. Consider asking customers to leave a positive review after a successful visit.

Remember that not all reviews are going to be a ringing endorsement for your company, so be certain to directly address bad reviews. Whether good or bad, give personalized responses to reviews as often as possible. Part of the appeal locally run body shops enjoy comes from the personal touches that can be brought to a customer experience. Overall, make sure that your shop’s personality shines through in your online presence just as well as it does in your physical shop.

Plan Future Appointments for Regular Services – While many body shop visits are specifically problem-based, services like oil changes can and should be scheduled in advance so customers keep your shop in mind when it is time for regular servicing to their vehicle. Capitalize on necessary procedures like annual inspections stickers and coolant flushes to keep regular customers as regular as possible.

Digital Services and Software Solutions

Body shops have modernized in parallel with the vehicles they repair. As car companies continue to integrate increasingly complex computer systems and unique parts into vehicles, body shops have shown continued resiliency in their ability to keep up with consumer expectations. Another consumer expectation that body shops met in stride was the demand for digital services during the COVID-19 pandemic. Digital multi-point inspections and procedures are a win-win for consumers and body shops alike as consumers can clearly see their vehicle’s condition and body shops can more meaningfully demonstrate what repairs are necessary or not urgent.

There are several companies that offer digital interfaces for multi-point inspections; one of the most well-known is Bolt On Technology whose digital inspection program allows easy photo integration and tablet use for technicians and mechanics. Compared to traditional paper inspection forms, digital interfaces provide numerous time-saving benefits for your mechanics while giving customers a streamlined look at their vehicle’s servicing needs.

Another software solution that body shops looking to tighten their bottom line may want to consider is management software like ProfitBoost, which allows shop managers and bookkeepers to consolidate parts and labor expenditure figures into an easy-to-read single platform. ProfitBoost gives shops the ability to quickly assess their spending and determine where they can expand or retract to help their bottom line.

Profit Margin Overview and Final Considerations

With overhead and parts costs as a constant necessity, it is a relentless balancing act for even the most successful body shops to keep their heads above water. There is no gimmick or guaranteed trick to increase a shop’s profit margin, but a valuable first step is making sure that your shop offers personalized and professional services at the highest caliber possible. When you make business decisions around this primary goal, you can expect profits to follow.