How does Working Capital affect Business Valuation?
As you may already know, working capital equals assets less current liabilities. Fact: Companies with primarily cash accounts receivable and inventory are not as appealing as those who have neatly managed their working capital.
Potential investors are wary of acquiring companies with high working capital since their growth attracts more working capital. Moreover, companies with low working capital tend to thrive faster and yield more revenue to shareholders.
Effective management of working capital is essential for business survival. More so, in a period of notable fluctuation activities such as the hospitality sector. In addition, in a business transaction, the level of working capital has a £ for £ effect on the equity value.
What is working capital?
It is current assets minus current liabilities. It refers to the amount of cash that a business can safely spend in its day-to-day trading operations.
What is a business valuation?
Simply put, it is the entire process of determining the economic value of a business.
With the varying government business packages to salvage businesses in the UK phasing out, company management teams should prioritise working capital management.
It is seen through:
- Use of Working Capital Management as a benchmark against Competitors
The Cash Conversion Cycle is a good sign of working capital efficiency as it clearly shows how long it would take to turn inventory and other assets into cash via sales. The lesser the number of days, the more effective the plan.
- Pre-deal (sell-side)
It entirely depends on how much time you have to prepare your business for sale. If you see yourself reaching the next fiscal year, you can plan for more than 12 months ahead.
For those looking short term, it’s six months or less. Tactical levers are put in place to help boost the management accounts.
Examples may include:
- Collection campaigns
- Rigorous control of your pay runs and cash outflows
- Compiling disputed invoices
- Timely reduction of stock and replenishing variables.
Over the last 12 months, most firms have regrouped investments into three categories:
It is brought about by different working capital enhancing measures in investment sectors. If you are looking to create value in new investment from an integrated business, cash should be a critical aspect of your priorities.
Below, Ernest & Co Accountants outlines different insights upon looking to improve your capital:
- Cash and working capital should be in the top three in strategic priority.
- Transparency is key to tracking company performance.
- Put working capital reduction targets in place.
- Other than the Finance Director, governance should cut across the business.
- Use incentives outside the executive team for optimal performance.
- Short-term cash flow forecasts and modelling scenarios help improve overall buy-ins.
- Have a clear roles and responsibility definition.
- Opt in to Supply Chain Financing hence giving smaller businesses access to cash.
- Along with a clear RACI matrix, have a Target Operating Model (TOM), in this case, the finance function.
- Enable TOM. You can do this by having better infrastructural systems in place, outsourcing or an enhanced employee skill sets.
Company owners should regularly reevaluate and consider working on their accounts payable, borrowing practices, reduce accounts receivable and inventory requirements. All these reduce working capital, bring in more cash, increase business growth and increases shareholder value.
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