Working Capital and Liquidity
A balance sheet forecast showing positive equity signifies solvency. That however does not signify whether or not the business is in a position to meet its liabililties as they fall due for payment.
Paying the bills on time depends on the liquidity of the business and that is broadly described by its net current assets. These are also known as working capital and if they are insufficient to generate cash as and when it is needed, there is a real chance that a business will face the prospect of cash flow insolvency; by far the principal cause of business failures.
For this reason the most important forecasts that Figurewizard produces for its users are those for the balance sheet, monthly cash flows and bank balances.
Managing Investments in Assets
The two golden rules for the management of current assets are that cash collection from accounts receivable is efficient and that the level of stock / inventory is such that its value is being turned over regularly throughout the year. These are measured by the forecasts for cash collection and stock / inventory performance ratios that Figurewizard produces .
Investment in fixed assets should only ever be justified by the strength of their predicted returns on that investment. Those returns must always be judged on their likely short term effect on working capital and cash flow as well as on profitability.
Fixed Assets and Cash
Acquiring fixed assets always come at a cost to working capital regardless of asset financing.
This is because plant and machinery, office equipment or commercial vehicles are regarded as being essential for the purpose of enabling business operations, so cannot be cash convertible. In addition their depreciated value represents their residual working life; not their market values.
Asset finance or credit will go some way to mitigate their costs to cash flow but in the short term at least there will be less cash for other things. Whereas the net book values of fixed assets are always ignored when calculating working capital and short term liquidity, asset financing repayments due within the next twelve months are charged to it.
Investing Beyond the Businesses' Means
With very few exceptions the plain and simple fact is that business failures only ever result from running out of cash.
Losses are the usual suspects but a business carrying assets beyond the capacity of the balance sheet to support them will do the job just the same. These include unnecessarily high values of stock / invetory or slow collection of accounts receivable. They can also arise where investment in fixed assets adds more to current liabilities than liquidity can absorb.