Alright, let’s talk product manufacturing cycles. At a super high level, here’s one one cycle looks like:
Now I’m not going to pretend that producing a product or a service is as simple as that. But what I will tell you is that finance has completely changed the way we manage the money for that process.
This concept is called Working Capital.
Assets - stuff you own & money owed to you.
Liabilities - money you owe.
Net Working Capital (NWC): the capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.
Think like this:
Your NWC: $100. You can use that $100 as long as you have $125 ready when you need to pay Bob back.
Now fast forward and the debts have been settled:
Your NWC: $25
Payment terms: number of days a business has after goods are exchanged to pay
Think like this:
Think about manufacturing in the real world. It takes time to transform raw materials into a product, move it out into the world and collect revenue.
Payment terms are an economic innovation that unlocks the liquidity inherent in the capital locked in real world production
Payable: short term debt a company owes for goods/services
Receivable: short term credit a company is owed for for goods/services
Think like this:
That’s all the vocab we need to know for this thread, let’s pull it together:
In an ideal world, you want to sell your product and then pay your suppliers. Revenue pays off the cost of creating the good and you keep the profit. And (between you & me) you might not be able to afford the cost of the materials until after the product sells.
However, regardless of if you sell your product or not, your supplier sold his product to you. He wants his cash ASAP.
Likewise, whoever you sold your product too wants as much time as possible to pay you.
There are millions of businesses in the world, all with specific needs and ambitions. They all negotiate (mostly) bilateral deals trying to measure their needs with their counter-parties’ limitations.
This is (a part of) the foundation of the financial economy.
The financial economy is distinct from the real economy.
Example, imagine two almost identical companies who sell breakfast cereal, A and B. Both produce a box for $1 and sell it for $3.
A has negotiated “ideal” payment terms: 21 days.
Production time is 7 days, sales cycle is 14 days. A pays supplier in 21 days.
When A produces and sells a box of cereal, they don’t need to pay for the grain, packaging, etc. until they receive payment for the finished good.
B is… more aggressive. Using its superior powers of negotiation (read: monopoly and monopsony power) to make more favorable deals.
B's payment terms: 121 days.
Cereal price: $3, Cereal production cost: $1
But this isn’t one box, one time. This is millions of boxes, all the time.
In reality, it’s more like “Company B has an extra, permanent $20MM.”
This concept works in both ways. We aren’t going to walk through it, but think about the inverse of Company B. That company would be paying its suppliers faster that it receives revenue. It would have a permanent hole of -$20MM.
This is the practice of working capital management (for most business, cash flow management is essentially working capital management). Cash managers, financial planners and raw materials buyers coordinate to maximize working capital and then deploy it productively.
I was explaining this, a friend said:
“If you manage working capital well, you turn your business into a bank. You’re pooling excess capital and looking for ways to deploy it effectively.”
That’s why I like you degens… you help us boomers see old concepts in new ways
Working capital becomes more important the more you understand it. Eventually you can use it to take over the world.
Proof? I did learned finance from men who’ve already done it with Net Working Capital > $1B.
“Dream Big. Dreaming small takes the same amount of energy”
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