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Finance Allah shmoop How does working capital work Well you

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had a vision a dream I hope that all mugs

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would have their own voice their own personality their own

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pathos their own swear word Well there was just something

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about swearing phrases that grabbed you emotionally since well as

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far back as you could remember And you think it

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probably had to do with your earliest memories of your

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mother swearing into the pain at your own You know

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AIPO that's wearing lasted about four years until it finally

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subsided when you left home for nursery school So every

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mug needed a swear This one the fishmonger model said

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And this one they road rage driver Model said And

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of course well the bestseller here The med student reading

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her student loan bill said Well how did all of

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this get it started Working capital Yeah you didn't just

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will the cups into existence You had to buy the

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generic clay mugs You had to buy a kiln to

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reheat them After you'd painted on your swear words you

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had to buy that special paint He had to set

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up a website through which to sell them You had

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to deposit two grand into a bank account so that

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you could take credit cards You had to do a

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little marketing You needed shipping boxes and that corn Styrofoam

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stuff that goes in and an upgraded computer from this

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one Teo this one and a few other things to

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get started Yeah so you needed that fifteen grand toe

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Have enough dough to begin mugs your new company That's

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capital to buy things But note that you're working out

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of your garage for a while taking no salary buying

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no insurance and setting up your own LLC through LegalZoom

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for two hundred bucks So you realize that unless you

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suddenly sell all thousand mugs for twenty bucks each and

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make serious bank while you're going to need more working

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capital in the very near future Note also that working

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capital lives entirely on the asset side of the balance

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sheet and it starts as cash But then that cash

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gets spent on various supplies You know mugs kiln website

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marketing so on And the cash in that original B

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of a account dwindles to almost nothing By the time

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the mugs is ready to go to market Well what

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happened while it transformed into other lines on the balance

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sheet like Well one line here Blank unpainted mugs Seven

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hundred Yeah you only put swear phrases on three hundred

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mugs to start and you're holding The value of those

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mugs is being whatever you paid for them or book

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value Maybe you'd get your money back if you had

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to return A maybe you wouldn't Probably you wouldn't But

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you don't want to test the system and the paint

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and kiln and so on They're all held it book

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value under the presumption that you could return them or

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sell them if you had to albeit at some loss

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but with no real info on what to go on

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Well you just hold them in book value on your

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balance sheet at least for now The rest of your

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cash spent on things like marketing which just goes away

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as soon if you commit to spending the money in

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the period you'll run the marketing so that dough just

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evaporates and well For the finished three hundred mugs they

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become inventory And while you hold a blank mug five

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bucks you hold a Finnish painted mug at seven bucks

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as you attribute to dollars in value to the and

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and you've painted on it And the mugs in the

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process of being bleeped Well they're a work in process

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sort of living in limbo between raw materials and finished

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inventory goods ready to sell So all of this activity

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has happened before you've sold a single mug but you

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raised fifteen thousand dollars before then The question how How

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did you raise that fifteen k Well you had two

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basic choices Borrow the money like take out a loan

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from the Bank of Grandmama or sell a slice of

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your pie if you took out alone while you'd show

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that fifteen grand is a dead on your balance sheet

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over here is a liability alone payable And in this

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case well let's assume it was all due to be

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paid back a year or less after you borrowed it

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You figured that well you'd either self mugs quickly or

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you'd be well bankrupt and or you know mowing grandmama's

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bond for years so that fifteen k lives is a

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short term Current liability will presumably pay Feli off someday

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with fifteen hundred bucks of interest that will have accrued

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because grandmama charge you ten percent interest on the loan

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per year to boot so well that'll be sixteen thousand

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five hundred You'll pay in a year of that point

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that fifteen hundred dollars of interests while you just add

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to your debts payable in installments each quarter as you'll

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see your short term loans payable go up by about

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three hundred seventy five bucks and change about every ninety

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one days So that's a loans way of raising cash

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our working capital to start your company You could have

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also sold Grandmama a slice or equity ownership in the

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company for that same fifteen grand like let's say you

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valued yourself is being worth one hundred thousand dollars to

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start that fifteen grand in stock she would have bought

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would then have been worth the fifteen over one hundred

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fifteen or about thirteen percent ownership in your company Well

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in this case you don't eighty seven percent and sheet

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on thirteen percent and you'd be paying no interest well

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because there'd be no loans Instead of the fifteen grand

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of working capital showing up as debt it would show

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up down here on the shareholder's equity line and just

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hang out there as fifteen grand until told otherwise that

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it should be worth more or less But yes of

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course you have the cash as well in your B

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of a account Right So that's a brief on how

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working capital works at the inception of a company You

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can imagine that if bugs took off and became huge

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you need to raise more working capital just to meet

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demand right Like what if orders for twenty five thousand

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mugs came in off the website Well all of a

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sudden you need to buy another twenty for thousand mugs

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at five bucks each and while there's another hundred twenty

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grand alone's you ask for the mugs let alone all

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the other supplies you need So yes it's great that

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you're selling twenty five thousand mugs that say twenty bucks

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each for half a million dollars in revenues but you

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don't collect that revenue entirely Half the orders were checks

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that were mailed in They take a while to clear

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in cash and so on And you know the five

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percent will return the bug with email that says this

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is not what I ordered so you need more working

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capital as your balance sheet expands and you need to

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be ableto handle the scaling up of your little company 00:06:07.75 --> [endTime] into a you know a big one

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