256 ENTREPRENEURSHIP
Overspending on non-critical areas is especially troublesome because of the signals it
sends to employees and vendors. Entrepreneurs sometimes waste money on things they
do not need: expensive art for the offices, luxury vehicles for themselves and other exec-
utives, first class travel, and retreats at fancy resorts. This says, in effect, “We have plen-
ty of money.” Customers will realize that they are paying for all of this through higher
prices—-if there are any customers left.
There must be a balance between raising so little money that the firm is unprepared
for a down cycle and raising so much that investors, suppliers, customers, and employ-
ees are adversely affected. Sometimes entrepreneurs raise too much money by selling or
encumbering too much of the business. The wise ones who resist the temptation to con-
tinue selling more equity than necessary can sell additional equity sometime down the
road when it is both really needed and much more valuable. This phased financingis
discussed in the next chapter.Working Capital and Cash Flow Management
The entrepreneur must focus on working capital and cash flow from the beginning of
the financing process. Accounting profits do not pay the bills; only positive cash flow
keeps a business solvent. It is estimated that over 60 percent of the average entrepre-
neur’s total financing requirements are invested in working capital, 25 percent in ac-
counts receivable alone.^4 Sufficient working capital is vital to the survival of the enter-
prise, and well-managed working capital and cash flow can significantly increase the
profitability of the new venture.Working Capital Concepts. Working capital has two components. Permanent work-
ing capital is the amount needed to produce goods and services at the lowest point of
demand.^5 Its form may change over the course of the cash flow cycle (for example, from
inventory to receivables to cash), but permanent working capital never leaves the busi-
ness. As the firm grows and sales increase, the amount of permanent working capital
increases as well. Temporary working capital is the amount needed to meet seasonal
or cyclical demand. It is not a permanent part of the firm’s financial structure. When
these peak periods end, temporary working capital is returned to its source.
A firm with too little permanent working capital runs the risk of losing business. If
inventory levels are kept too low, stockouts occur and sales are lost. If the venture’s
accounts receivable policy is too restrictive, good customers who prefer to pay on cred-
it may turn away. If cash balances are too low, the venture runs the risk of being unable
to procure supplies or pay its bills. This diminishes its ability to take advantage of short-
term purchasing opportunities and damages its reputation.
An enterprise with too much working capital for a given level of sales is inefficient.
Stock and inventory levels will be much higher than necessary to fulfill customer orders.
Receivables will represent too large a percentage of sales, and the venture will be provid-
ing inexpensive financing for its customers. Cash levels will be more than needed for
transactions and precautionary uses. Each dollar invested in working capital must return
at least the internal rate of return of the rest of the venture’s investment to be “pulling
its weight” in the financial structure.