Working capital is the short term liquidity (read: cash) required to operate a business. Working capital is defined as Current Assets (primarily accounts receivable and inventory) less Current Liabilities (primarily accounts payable).

When Current Assets increase (inventory goes up), cash goes down. When Current Assets decline (inventory goes down), cash goes up. Likewise, when Current Liabilities increase (payables go up), cash goes up. When Current Liabilities decline (payables go down), cash goes down.

Each of our portfolio companies have different working capital "situations", some more advantageous than others.

Our magazine publishing company has the most traditional working capital situation. When it sells advertising, customers generally receive terms (net30) and so the company carries accounts receivable from advertisers. Current Assets up, cash down. The company also owes money to various vendors that we work with including our printer, freelance writers, etc. It carries these as accounts payable. Current Liabilities up, cash up.

This is about as simple or traditional a working capital arrangement a business can have and results in some matching between cash uses  (increase in receivables) and cash sources (increase in payables).

Our event rental company has an advantageous working capital situation. It collects deposits from customers in advance of completing a job. These customer deposits are a current liability. Current Liabilities up, cash up. At the completion of the job, it typically receives final payment. A receivable is created and instantly paid. Current Assets down, cash up. Some of it's vendors provide terms so it carries account payables. Current Liabilities up, cash up. Cash up, cash up, cash up. Hard to beat that arrangement.

Our eyewear distribution company has a disadvantageous working capital situation. Like most distributors, it buys inventory from suppliers that require substantial upfront deposits before they will begin manufacturing product, then an additional payment when the product ships. These deposits are Current Assets. Current Assets up, cash down. The company makes a final payment when the product hits it's warehouse and becomes inventory. Current Assets up, cash down.  The company sells the product to its customers on terms of Net30, creating accounts receivable. Current Assets up, cash down. The company carries some accounts payable, helping to offset the significant amount of inventory and accounts receivable. Current Liabilities up, cash up. Overall, the working capital position is pretty rough. Cash down, cash down, cash down, cash up.

Managing working capital is critical to the cash flow of any small business. Small businesses with disadvantageous working capital positions may require a working capital line of credit (also know as an asset-based revolver or revolving loan) in order to finance operations, particularly during periods of rapid growth.

Below are reflections on some of the topics covered at the G20 YES Summit this week...

Reflections on innovation...

Shai Agassi, founder and CEO of Better Place.  Better Place is attempting to revolutionize the auto industry while also reducing reliance on oil. 

Imagineering.  This is a word that has influenced Shai's career and it was one I have never heard before.  As Shai describes it, imagine with no boundaries, but then bring it back to the realities of your engineering constraints.  You don't want your thoughts and imagination to be restricted, but at the same time an idea is only useful if it can actually be produced.

Its not a revolutionary concept, but I have never heard it as eloquently described as Shai was able to do so.

on capitalism...

Professor Muhammad Yunus, Economist, Founder Grameen Bank and Nobel Peace Prize Laureate

In his stirring speech to the G 20 YES delegates this week, Prof. Yunus reminds us not to blame poor people for their situation but instead to focus on ways to help solve the problem.  He presented microfinance and Grameen Bank as an example of a social business that is both a) sustainable on its own and not dependent on government or other sources of financing and b) has helped lift tens of thousands people out of poverty.

His speech reminded me of the One Acre Fund, another social business with similar goals.

While some of the protesters at this week's events proclaim that capitalism has failed, listening to Prof Yunus extol the benefits of capitalism and its ability to create sustainable and socially conscious businesses that are not dependent on government subsidies reminds all of us that its not the governments job to eliminate unemployment or poverty, but rather to provide a framework wherein capitalism can thrive.

on risk-taking...

Mouna Sepehri, an Executive Vice President at Renault

"There are many ways to fail, but the surest way to fail is not to take any risk": Sepehri started off her speech at the G 20 YES event with this quote which she attributed to Benjamin Franklin - one of America's greatest inventors.

People are generally afraid of failure, and failure in some cultures carries a stigma or a financial burden that can last a lifetime.  Yet, as Franklin points out, not trying is a failure too.  At Hadley Capital we are always looking to minimize the risks that our portfolio companies take, but at the same time, we understand that to create long term value, sometimes you have to take calculated risks.  We invest millions of dollars in companies supporting management teams and helping them analyze their investment options.  While we don't want to fail, we also know that you can never win the game unless you are in the game.

SBD

We're starting to work with our portfolio companies on their 2012 budgets. We use budgets to help our companies:

Forecast revenue - Who are our most important, most profitable customers/programs/products, what new revenue can we expect this year, is any revenue is at risk? For most of our companies, this is the most difficult aspect of budgeting and requires the most effort/thought. Some of our companies have more predicable revenue streams than others but each company produces a monthly revenue budget.

Control expenses - What are the costs of earning our forecasted revenue - manufacturing costs, selling costs, etc.? What are our fixed costs for the year - rent, utilities, insurance, debt service, etc. What are our variable expenses and which can be trimmed back if our revenue does not meet plan? Where can we be more efficient? In our experience, controlling costs begins with setting profitability goals on a per project/product/customer basis. Our companies also continuously seek ways to become more efficient in G&A spending - from utilities to office supplies to occupancy costs to insurance to credit card processing.

Make investments - If revenue minus expenses meets our profit goals then we focus on investments in the future. Which new programs will we implement, what will they cost, what is our expected return on investment? This year our companies will make new investments that range from new product launches to hiring new employees to acquiring new equipment to opening new locations to implementing new ERP systems to making acquisitions of complementary businesses.

Set rewards - Developing a detailed budget provides our managers with clear expectations for required outcomes. We work with the managers of our companies to set rewards (for management and employees) for achieving or exceeding these outcomes and aligning their interests with ours.

The last couple of years have been interesting times but disciplined budgeting has been one strategy that has helped our companies weather the storm. While know one knows what 2012 will hold, we are optimistic that the economy will continue to improve and that a rising tide will lift all boats...but if the tide goes out our companies won't be caught swimming naked.

PDW

With unemployment above 9% it is amazing to me that Hadley Capital's companies are having trouble finding qualified candidates to fill open positions. For a recent opening for a Controller we received more than 300 resumes and only a handful, less than 10 candidates, had the functional and interpersonal skills required for the job. Yesterday I received an email from one of our managers that highlighted this dichotomy, she wrote: "we are actively searching for qualified sales reps but have been very disappointed in who is applying..."

Recent news from the National Federation of Independent Business, a leading small business advocacy group, and the Federal Reserve Bank of New York confirm that our companies are not alone. The NFIB reports that 33% of small businesses reported having few or no qualified applicants for job openings. The Federal Reserve Bank of New York reported even more depressing statistics – nearly 60% of all respondents to the Empire State Manufacturing Survey report difficulty finding workers who are proficient in advanced computer skills, interpersonal skills and punctuality/reliability.

Read that last sentence again: manufacturers report difficulty finding workers who are proficient in showing up on time and being reliable. Unreal.

PDW