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Managing your working capital

Getting your head around key numbers, like your working capital, can help you spot risks and know when you’re in a financial position to jump on an opportunity. Find out more.

What is working capital?

Working capital is the money your business uses for day-to-day operations. It’s those assets that can easily be turned into cash (eg stock), minus your outgoings and short-term debt. It provides a snapshot of your business’s liquidity.

Why is it important?

Your working capital shows how your current assets stack up against your current liabilities. It shows if you’re going to be able to sustain day-to-day operations and meet short term obligations.

By keeping an eye on it, you can also spot opportunities to improve the flow of money into and out of your business.

Positive working capital shows you have more current assets than current liabilities and your business is in a good position to cover your day-to-day operating costs and obligations.

Negative working capital means you can’t cover current liabilities, and you have more cash flowing out of your business than flowing into it.

Calculating your working capital

You can calculate your working capital by subtracting your current liabilities from your current assets. You can find these figures on your balance sheet.

How to read financial statements

The focus is on current assets and current liabilities rather than long-term assets or liabilities, because working capital is used to gauge the short-term liquidity of your business.

Current assets are short-term assets like cash, or other assets that could usually be converted to cash within a year. They can include things like: 

  • inventory 
  • short-term investments 
  • accounts receivable. 

Current liabilities are short-term debts and obligations that are due within a cash conversion cycle or a financial year. They can include things like: 

  • loans and other debts 
  • payroll 
  • taxes 
  • accounts payable. 
You might have positive cash flow, but negative working capital if your business is carrying large debts.

You might have positive cash flow, but negative working capital if your business is carrying large debts.

How to work out how much capital you need

Step 1: Understand your cash conversion cycle

Your cash conversion cycle is a measure of how much time it takes to turn your inventory into sales, and then into cash.

It impacts your working capital requirements, because the longer the conversion cycle, the longer you’re waiting to get cash into your business to pay things like salaries or wages, rent and other expenses.  

To work out your cash conversion cycle, look at your:  

  • Inventory days: the number of days you hold stock before selling it.
  • Receivable days: the number of days it takes a customer to pay you for goods or services.
  • Supplier payment days: the number of days it takes your business to pay its suppliers.

Add together your inventory days and receivable days, then subtract your supplier payment days to get the number of days in your cash conversion cycle.

Step 2: Calculate your working capital requirements

You can estimate how much working capital you need by multiplying the average number of sales you make each day by the number of days in your cash conversion cycle.

Average sales per day x cash conversion cycle = working capital requirements

If this estimate is higher than what you’ve calculated your current working capital to be you’ll need to look at ways to make up the difference, such as a loan or other financing.

Speeding up your conversion cycle

You can look at ways of shortening your conversion cycle by:

  • issuing invoices promptly
  • talking to suppliers about extending the time you have to pay for things
  • asking customers for payments or deposits upfront
  • not ordering inventory earlier than you need to
  • ordering the right amount of inventory at the right time
  • chasing up payments.

Order inventory wisely

How to work out your inventory cycle

Step 1: Calculate your average inventory (your inventory balance will be on your balance sheet)

  • Average inventory = (starting + ending inventory balance) divided by 2.

Step 2: Calculate your average inventory days (the cost of goods sold will be on your income statement)

  • Average days inventory = (number of days a year × average inventory) divided by cost of goods sold.

Other useful resources

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