Money Flows
Visualising the flow of money as water helps to understand where it’s flowing properly, where it’s leaking, and where it’s backing up. That’s why the Phillips Machine was invented – a hydraulic device for modelling monetary flows through the economy. Bill Phillips was a genius, because even if his device didn’t capture factors such as inflation, his concept of creating a visual model helped a generation of economists understand how economics worked.
Another visionary who used water to understand how his field worked efficiently is Bruce Lee – yes - “Enter the Dragon” Bruce Lee! He used water as a metaphor for flow and adaptability in his martial arts principles.
Money is a resource
Running a successful business means getting efficient at allocating resources to effectively generate income & profit.
Money flows into the business and you determine where it is held and how it is used before the value of what you’ve created leaves the business and returns to go through the process again.
Visualising the money flowing in and through the business
Let’s do a quick visualisation exercise – get ready to close your eyes and think about:
1. Cash coming into your business as a series of dams or gates:
o from owners
o from retained profits
o from lenders
o from customers
2. Some of the water/money will flow out of the business to pay for operating expenses:
o Research & Development
o Sales & Marketing
o General & Administration
3. Next think about the Working Capital reservoir you direct the water/money into:
o Buying Inventory
o Items in Production / Assembly
o Goods sold but not yet paid for
4. And the remainder flows through to the Cash Balance dam.
Working Capital Management: identifying where money is generate value or backing up in the business
A business needs money flowing into its working capital reservoir because that generates value – therefore the quicker that money flows the quicker the value (ie profit) arrives.
This is why being able to manage working capital efficiently is key to growing your business. Let’s look at a comparison of two almost identical businesses to illustrate – Strictco (manages working capital strictly) and Lazyco (doesn’t):
Strictco | Lazyco | |
Debtor Days | 30 | 60 |
Inventory Days | 30 | 60 |
Creditor Days | 45 | 45 |
Working Capital Days | 15 | 75 |
(Debtor + Inventory - Creditors) |
Lazyco takes 5x longer to convert cash outflows (inventory purchases) to cash inflows (Debtor receipts) than Strictco.
What do their Working Capital cash reservoirs look like?
Strictco | Lazyco | |
Sales | 500,000 | 500,000 |
Cost of Goods Sold | 300,000 | 300,000 |
Gross Profit | 200,000 | 200,000 |
40.00% | 40.00% | |
Inventory Balance | 24,658 | 49,315 |
Debtor Balance | 41,096 | 82,192 |
Creditor Balance | 36,986 | 36,986 |
Working Capital Balance | 28,767 | 94,521 |
(AR + Inventory - AP) |
Lazyco has 3.3x cash than Strictco tied up in Working Capital!
Lazyco clearly has a problem – but it becomes much worse when the businesses want to expand:
Strictco | Lazyco | |
Sales | 500,000 | 500,000 |
Working Capital Balance | 28,767 | 94,521 |
Working Capital % of Sales | 5.8% | 18.9% |
Because Lazyco is more than 3.3 times less efficient at managing working capital, it needs to have $18.90 cash to invest in working capital for every $100 additional sales it makes. Here’s what an additional 35% Sales means in terms of working capital investment:
Strictco | Lazyco | |
Sales | 625,000 | 625,000 |
Working Capital Balance | 35,959 | 118,151 |
Working Capital % of Sales | 5.8% | 18.9% |
Additional Sales | 125,000 | 125,000 |
Additional working capital required | 7,192 | 23,630 |
Many businesses get into trouble when they expand quickly without being able to fund their working capital growth. Luckily it’s clear to see how Lazyco can reduce its additional cash required.
Enter the Dragon
“The successful warrior is the average man, with laser-like focus.”
Roger Bannister was the first person to break the 4-minute mile, in 1954 after people had been trying for decades to do so. A year later, 3 runners broke 4-minutes in a single race.
Once we know something can be done, it’s a lot easier to do it yourself. Lazyco knows that it is possible to reduce its working capital days because Strictco has already done so.
Lazyco can aim to perform as efficiently as Strictco – improve debtor management, renegotiate contract terms, tighten Material Requirements Planning (MRP) settings, regular stock reviews, marketing to clear out older stock, etc …. In the martial art of working capital management you set your targets, match your processes to targets, and consistently execute.
But since we know we can achieve something that’s already proven possible, why only aim to be as efficient as Strictco? Why not base your target on a business that’s even more efficient?
Costco is the new Roger Bannister
Costco is the world’s third largest wholesaler after Walmart and Amazon. It’s annual revenue was about USD 223 billion in 2022, and it has NEGATIVE WORKING CAPITAL.
Basically as Costco grows, it prints cash.
It doesn’t have a high net profit margin, but let’s be honest: if every time your business grew you just keep generating cash faster than you spend it, would you mind?
You don’t need to run your business exactly like Costco, you just need to know that negative working capital is possible.
The analysis in this article is the same that we apply to our clients' businesses.
Find out more about how we can help your business.