Very few businesses have steady and equal activity each month of the year. As such,
First, let’s define “Working Capital”. In accounting terms, it's the company’s total current assets (i.e. cash, accounts receivable) less its current liabilities (payables). The only problem with this formula however is that in most small business purchases, the seller takes the receivables and pays off the payables at closing to deliver the business “free and clear”. Or, in numerous businesses, there may not be much in the way of current assets.
So here you are on day one and you start incurring expenses. However, what if the Revenues during the immediate period don't generate enough to cover them? Simple, you have a shortfall and you had better have ample capital to fund the loss or you will be out of business faster than you got into it.
I don't want to scare you; I want to prepare you. The first thing you must do is consider the seasonality of the business. Using historical financials get a very clear understanding of what the business will generate each month/quarter as a percentage of the total sales. Then break it down further to the Gross Profit amount (i.e. after you pay for the inventory or other Cost of Goods Sold). This amount represents what you will have available to pay your bills.
I always recommend anticipating a decline in the revenues for a 3-6 month period after a new owner takes over a business. I do this because (a) it usually happens as a new owner familiarizes themselves with the business and (b) to be ultra-conservative.
Then, it's simple math: will you have adequate cash to cover costs? If no, you will need to inject additional capital or arrange a working capital loan.
Typically, these are ones associated with the sale such as the principal and interest due on any note associated with the sale. Negotiate a payment holiday for the necessary amount of time.
Keep in mind however that except for very large deals, you will likely have to pay back part or all of it.
You may be saying that you’ll simply buy the business during its historical best periods. Great idea! Unfortunately, it doesn’t always work and you may be sitting around while the seller finds another buyer. Further, talking over a business in its peak selling season can prove to be a horrendous way to learn the business. Personally, I prefer starting when it’s quiet so I can learn the business properly in order to be fully trained and prepared for the peak season.
To summarize: get a very clear handle on how the business breaks down percentage-wise month by month. Understand your expenses. Be realistic in projecting sales – remember it's always better to be conservative. If sales exceed projections it's very easy to live with the scenario, but not so if they fall short.
If you do your projections properly, you almost always can have some leverage and support from the seller since they too know the seasonality issues the business faces. Most importantly, make sure you have adequate reserves or access to some. Remember the old adage to “save for a rainy day”. If you go into a business undercapitalized that rainy day will quickly become a monsoon.
This article represents a fraction of what you’ll learn on this topic in the How To Buy A Good Business At A Great Price© series - the most widely used reference resource and strategy guide for buying a business. To learn more click here
Global Political Concerns And Buying A BusinessIf you listen to news outlets and read articles from across the political landscape, it would be easy to believe that the world is abContinue Reading >
It's normal for a buyer to experience concern and apprehension as they close in on a deal to buy a business. What buyers often don't anticipate however is being hit with remorse frContinue Reading >
I try to read every article about business buying and selling and specifically in regional markets across the globe. If one were to believe the contents of each one, you could go cContinue Reading >