The importance of being in a positive working capital situation

Working capital (WC) is the operating liquidity available to a business and is calculated as current assets minus current liabilities.

A business can be highly profitable and have a lot of assets, but still short of liquidity if its assets cannot readily be converted into cash. Sadly many highly profitable businesses have gone into liquidation due to working capital mismanagement. Positive working capital is required to ensure that a business is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.

One measure of cash flow is provided by the cash conversion cycle – the net number of days from the outlay of cash for raw material or inventory to receiving payment from the customer. Naturally the lower this number is the better.

Management of working capital involves:

  • Cash management – Identifying the cash balance which allows for the business to meet day to day expenses without having ‘lazy’ cash on hand.
  • Creditor management – Identifying the payment terms of creditors that help fund your business but are not excessively unfair to suppliers.
  • Inventory management – Identifying the level of inventory which is optimal for the business and doesn’t result in stock-outs, but reduces the investment in inventory.
  • Debtor management – Identifying credit terms which will attract customers, but that can be economically funded.
  • Short-term financing – Identifying the appropriate source of financing, given the cash conversion cycle. Ideally inventory is financed by the supplier’s credit, but a bank loan or overdraft will be necessary to finance the debtors.

Cash for a business is like blood for people – essential to survival.


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