The ABCs of Small Healthcare Business - Operating Capital

A small business is like a machine that uses and hopefully makes money. You need to have enough money to get the machine started and keep it running.  Once running, a successful business can generate enough money to be self-sustaining. More successful small businesses produce money in excess of expenses (profits) that can be used to grow the business.  Most potential small business owners understand they need funds to purchase assets, supplies and perhaps do some marketing before they get started.  But often they do not realize that a chunk of money will be needed to keep the engine running.  This is called operating capital.  Operating capital is fundamentally necessary to keep the business from going under.  Most small businesses fail because there isn’t enough money to keep the engine running, also called cash flow. The first step in managing cash flow is to look ahead and understand upcoming expenses versus upcoming revenue AND when they are likely to occur. 

How do you determine what amount of operating capital is needed? The first step is to build a model of revenues and expenses.  In other words, money coming in from sales vs money going out for expenses such as payroll. The unfortunate reality for health care businesses that depend on payment from the state or insurance companies is that payment may not arrive for weeks or months after services have been provided. This is very different from other types of service businesses where payment is received upon completion of services or possibly even before.   

Your staff will want to be paid within a couple weeks or less of when they worked. That means that your expenses come first and payment for those expenses comes much later.  Operating capital is the amount of money you need to pay all those expenses until the revenue comes in. Let’s say, for example, you have four full-time employees for your adult family home.  Your payroll could be $10,000 every two weeks. Of course, there are other expenses; possibly rent, food, supplies and house maintenance. Let’s estimate those at $1000 a every two weeks. If it takes 30 days for the state to pay claims, then you’re going to need at least $22,000 in operating capital or you will run out of cash to pay your employees. It may take 60 days for private insurers to pay.  Then you will need twice as much - $44,000 in operating capital to keep from going bankrupt. 

Obviously, fewer employees and expenses results in lower operating capital. You may be able to get family members and relatives to work for little or no pay as you get started.  This could also significantly reduce the operating capital you need. In this case, however, you will have to consider how your staff will support themselves until the revenue starts coming.