Mr. Shyam was worried that his business was not churning enough cash flow despite being profitable.
So he appointed Kelkai – a financial consultant to study his business and find out what’s the reason for the shortage
After one week of intense study he came to following conclusion:
“Sir the Profit margins are very good in your business, but cash is not generated in the same proportion”
He went on to explain the concept of working capital:
No. of days to fulfill the order: In your business, it takes 33 days to fulfill the order
No. of days to collect the money: On an average customer pays in 72 days from the date of raising the invoice
No. of days to pay the vendor: In your business, you get credit of 42 days to pay your vendors.
To summarize, it takes 105 days to collect the money and 42 days to pay your suppliers. In effect, there is gap of 63 days in your business.(72+33-42)
To this extent you need to have funds for running the business.
On Top of this, you need to add monthly fixed costs.
In your business, average monthly sales is 60 lacs, the profit margin is 15%. So the working capital requirement is INR 1.02 cr (60 lacs*85%*2 months). Also there is fixed expenses of 14.5 lacs. So you need to have 1.17cr of funds to run the business smoothly
On hearing this, Shyam understood why his business was not generating cash on time. He implemented following steps to reduce the working capital cycle
- Increased the efficiency by 35% to fulfill the orders fast
- Better receivable management.
With this two initiatives, he brought the down the requirement of working capital in his business. This also resulted in lowering of interest cost as funds were borrowed and more importantly less headaches.
At Soatech, we specialize in instilling financial discipline in the business through working capital and process optimization