Working capital

What it means

Working capital is the difference between current assets and short-term liabilities - the amount a company permanently holds in inventory and receivables and has to fund somehow.

In practice it reads as a cycle length: you buy goods, pay for them, sell them, wait to be paid. The days between paying the supplier and collecting from the customer are precisely the gap that money has to cover.

Negative working capital is not automatically a bad sign. A shop that collects from customers at once and pays suppliers a month later is running on its suppliers’ money. In a manufacturer with long customer payment terms, though, the same figure signals that short-term liabilities are also funding assets that will not turn into cash that quickly.

How it works in practice

Three levers shorten the cycle: shorter payment terms on sales invoices, higher inventory turnover, and longer terms from suppliers. Each frees cash without borrowing anything.

Revenue growth raises the working capital requirement almost in proportion. So planning an expansion means calculating not only margin but how much cash will be tied up - and that calculation belongs in the cash flow plan.

When the company’s own working capital is not enough, the usual answer is a working capital loan or an overdraft. The bank looks precisely at stock and receivables, so we prepare an ageing breakdown for the client - old receivables and slow-moving stock are often not counted towards the security at all.

What to watch out for

This is exactly where a fast-growing company gets into trouble: revenue rises, profit is positive, but the money is in the warehouse and with customers. Funding growth from operations with no buffer is the commonest route to losing liquidity.

A second mistake is buying fixed assets out of operating cash. Paying for a machine or a car from the current account cuts working capital in one go, and the company then has nothing to pay suppliers and wages with, even though the investment itself was sound. Such a purchase belongs on an investment loan or a lease with instalments spread over the asset’s useful life.