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All about working capital

Bridget Holmstrom - Saturday, February 14, 2015

Why is working capital important

Businesses, especially new business start ups, often come to understand the importance of working capital when it is too late and as a consequence they fail.  Working capital is the resource that business need to pay their employees, suppliers and HMRC.  Having enough working capital means that managers can make long term plans to benefit their company.  Insufficient working capital means that the business risks not being able to pay their debts and go into liquidation. It can mean that the manager spends more time trying to find the cash to pay invoices and employees rather than making plans for the future.  Insufficient working capital can also mean that the business will miss out on business just because they cannot afford the additional demands upon the resources. 

What is working capital?

At is most simple working capital is the difference between current assets and current liabilities.  For the most part companies need to have more current assets than current liabilities as this means that they can cover the money owed to creditors such as trade suppliers, HMRC and their bank should they have an overdraft.

Current assets are:
  • trade debtors - cash that our customers owe us
  • cash and bank accounts - amounts that we can easily access 
  • stock - goods that we have not yet sold or used in the manufacturing process
Current liabilities are:
  • trade creditors - cash that we owe our customers
  • HMRC - amounts that we owe in tax
  • bank overdrafts and short term loans

The working capital cycle

It can help to think of working capital as operating in a cycle.  The cycle starts with the company buying goods and services from suppliers and making payment, these goods then go into stock until they are processed and sold.  The customer then owes the company money until the invoice is paid.  The cycle then starts again.  The longer the period of time between the company pays the supplier and the customer paying the invoice then the more resources the company must commit to ensure the business remains afloat.  Some industries have a naturally quick cycle because the customer pays immediately, you can think of retail where the customer pays immediately.  Other industries have a much longer cycle because there is a long manufacturing process and the customer then pays upon agreed credit terms.  

Influencing the working capital cycle

There are ways that managers can improve the working capital cycle.
  • paying the supplier to terms, and not before
  • reducing the amount of time that customers take to pay their invoice
  • reducing the amount of time that purchased goods remain in stock
  • reducing the amount paid for goods and services
  • controlling labour costs
  • ensuring that the price paid by the customer exceeds the costs paid to suppliers by a significant margin
If you wish to find out more contact Bridget on