What Is Working Capital?

Working capital is the money a business has available to run its day-to-day operations. It pays suppliers, wages and overheads while the business waits for customers to pay. When directors say cash is tight, they are often describing a working capital problem rather than a lack of profit.

Understanding how it moves through your business makes pressure easier to spot early and the right response easier to choose.

Working capital in plain English

The standard definition is current assets minus current liabilities.

• Current assets are things the business owns that should turn into cash in the short term. They include cash in the bank, stock, and money owed by customers, often called debtors or trade receivables.
• Current liabilities are amounts the business must pay in the short term. They include money owed to suppliers (creditors or trade payables), short-term borrowing such as an overdraft, wages and tax due.

If current assets are greater than current liabilities, the business has positive working capital. On a UK company balance sheet, this figure usually appears as net current assets, or net current liabilities if the position is negative.

A negative figure is not automatically a problem. Some business models collect cash from customers before suppliers are paid. For most businesses selling on credit, though, a sustained negative position deserves attention. Your accountant can explain what your own figure means.

The working capital cycle

The balance sheet shows working capital at a single date. In practice it is always moving. A typical cycle looks like this:

1. The business buys stock or materials, or pays staff to deliver a service.
2. It holds the stock or carries out the work.
3. It makes a sale and raises an invoice.
4. The customer pays on its agreed terms, and the invoice becomes cash.

Three items control how much cash this cycle absorbs:

• Stock. The longer it sits before being sold, the longer cash is tied up.
• Debtors. The longer customers take to pay, the longer the business waits for its money.
• Creditors. The more time suppliers allow, the longer the business can hold on to its cash.

The gap between paying out and getting paid is what working capital has to cover. Faster-moving stock, quicker-paying customers or longer supplier terms all narrow it.

Why profitable companies can run short of cash

Profit and cash are measured differently. A sale counts towards profit when it is made, but the cash may arrive much later. A business can therefore report healthy profits while its bank balance falls.

Common causes include:

• Growth. More sales usually means more stock and more money owed by customers before any of it is collected. Growing businesses often feel this most.
• Slow payers. One large customer paying late can disrupt the whole cycle.
• Seasonal trading. Stock and staff may need paying well before the busy period brings in cash.
• Payments that do not reduce profit straight away. Loan capital repayments and equipment purchases take cash out of the business immediately, but they are not charged against profit in the same way.
• Lump-sum payments. VAT, corporation tax and annual costs such as insurance can fall due when cash is already stretched.

How businesses manage working capital gaps

Most businesses use a mix of operational changes and funding.

Operational steps usually come first: invoicing promptly, chasing overdue accounts, agreeing workable supplier terms and keeping stock in line with demand. Our guide on how to improve business cash flow covers these in detail.

When the business is healthy and the pressure comes from timing, funding can bridge the gap. Different products target different parts of the cycle:

• Debtors. Invoice finance releases cash tied up in eligible unpaid invoices, and the funding available typically moves with the sales ledger.
• Stock, suppliers and payroll. Working capital finance, such as a revolving facility or short-term loan, can cover costs that fall due before customers pay.
• Large purchases. Asset finance spreads the cost of vehicles and equipment, so a single purchase does not drain the cash the cycle depends on.

The right choice depends on which part of the cycle is causing the pressure and whether the need is temporary or ongoing. If you are weighing up the main alternatives, see working capital finance vs a business loan.

Key points

• Working capital is current assets minus current liabilities: the money available to run the business day to day.
• Stock, debtors and creditors determine how much cash the working capital cycle absorbs.
• Profitable businesses can run short of cash, especially when growing or when customers pay late.
• Gaps can be managed through operational changes, funding, or both, depending on the cause.

This guide is general information, not financial, legal or tax advice. Finance is subject to status, eligibility and approval by the relevant finance provider. Emirex Finance works with UK limited companies only and is not authorised or regulated by the FCA.