Working Capital Management: Keep Your Business Running Smoothly

Working capital is the fuel that keeps your business running day to day. Without enough, you can’t pay suppliers, meet payroll, or take advantage of opportunities—even if you’re profitable on paper.

Understanding and managing working capital is essential for business survival and growth.

What Is Working Capital?

Working Capital = Current Assets - Current Liabilities

In simpler terms: What you have available to work with minus what you owe soon.

Current Assets

Assets that are cash or convert to cash within one year:

• Cash and bank balances
• Accounts receivable
• Inventory
• Prepaid expenses

Current Liabilities

Obligations due within one year:

• Accounts payable
• Accrued expenses
• Short-term debt
• Current portion of long-term debt

The Working Capital Calculation

Current Assets
Cash	$50,000
Accounts Receivable	$75,000
Inventory	$40,000
Prepaid Expenses	$5,000
Total Current Assets	$170,000

Current Liabilities
Accounts Payable	$35,000
Accrued Expenses	$15,000
Short-term Debt	$20,000
Total Current Liabilities	$70,000

Working Capital: $170,000 - $70,000 = $100,000

This business has $100,000 cushion between what it can access and what it owes short-term.

Why Working Capital Matters

Operational Continuity

Working capital funds daily operations:

• Buying inventory before selling it
• Paying employees before collecting from customers
• Covering expenses during seasonal slow periods

Without adequate working capital, operations stall.

Opportunity Capture

Good working capital enables you to:

• Take advantage of supplier discounts
• Buy inventory when prices are low
• Pursue new customers or projects
• Weather unexpected challenges

Lender Confidence

Banks and lenders evaluate working capital:

• Adequate working capital = lower risk = better terms
• Insufficient working capital = higher risk = harder to borrow

Business Value

Buyers and investors look at working capital:

• Healthy working capital indicates a well-managed business
• Poor working capital raises red flags

The Cash Conversion Cycle

Working capital efficiency is measured by the Cash Conversion Cycle (CCC):

CCC = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding

In plain terms: How long from when you pay for inventory until you collect cash from customers?

Example Calculation

• Days Inventory Outstanding (DIO): 45 days (How long inventory sits before being sold)

• Days Sales Outstanding (DSO): 35 days (How long to collect from customers)

• Days Payable Outstanding (DPO): 30 days (How long you take to pay suppliers)

CCC: 45 + 35 - 30 = 50 days

You’re floating 50 days of working capital needs.

Why CCC Matters

Shorter CCC = Less cash tied up in operations = More available for other uses

Longer CCC = More cash needed just to operate = Less financial flexibility

Managing Working Capital Components

Managing Receivables

Goal: Collect faster without losing customers

Strategies:

• Invoice immediately upon delivery
• Offer multiple payment methods
• Provide early payment discounts
• Follow up on overdue accounts promptly
• Be selective about extending credit

Metrics to track:

• Days Sales Outstanding (target: close to your payment terms)
• Aging of receivables (target: minimal over 60 days)
• Collection rate

Managing Inventory

Goal: Have enough without tying up too much cash

Strategies:

• Track inventory turns
• Implement reorder points
• Identify slow-moving items
• Consider just-in-time where possible
• Negotiate consignment arrangements

Metrics to track:

• Inventory turnover (higher is generally better)
• Days Inventory Outstanding
• Obsolete inventory percentage

Managing Payables

Goal: Use available terms without damaging relationships

Strategies:

• Pay on due date, not before (unless capturing discount)
• Take early payment discounts when ROI makes sense
• Negotiate extended terms with key vendors
• Prioritize critical vendor relationships

Metrics to track:

• Days Payable Outstanding
• Early payment discount capture rate
• Vendor relationship health

Working Capital Ratios

Current Ratio

Formula: Current Assets / Current Liabilities

Interpretation:

• Above 2.0: Strong, perhaps excess liquidity
• 1.5-2.0: Healthy
• 1.0-1.5: Tight, monitor closely
• Below 1.0: Potential trouble meeting obligations

Quick Ratio

Formula: (Current Assets - Inventory) / Current Liabilities

Interpretation:

• Above 1.0: Can meet obligations without selling inventory
• Below 1.0: Dependent on inventory liquidation

Working Capital Ratio

Formula: Working Capital / Total Assets

Shows what portion of assets is working capital. Higher indicates more liquid business.

Common Working Capital Problems

Problem: Growing Business, Tight Cash

Symptom: Revenue increasing but always short on cash

Cause: Growth requires more working capital—more receivables, more inventory—before cash comes in.

Solutions:

• Tighter receivables management
• Deposits or progress billing
• Supplier financing or terms
• Line of credit for working capital needs

Problem: Seasonal Business

Symptom: Cash great in peak season, desperate in off-season

Cause: Revenue varies but many costs are fixed

Solutions:

• Build reserves during peak
• Reduce fixed costs where possible
• Seasonal credit line
• Diversify revenue streams

Problem: Large Customer Concentration

Symptom: Cash flow depends on when one or two customers pay

Cause: Over-reliance on few customers

Solutions:

• Diversify customer base
• Negotiate better payment terms
• Invoice financing or factoring
• More frequent billing

Problem: Inventory Buildup

Symptom: Warehouse full, bank account empty

Cause: Buying too much inventory, slow-moving items

Solutions:

• Improve demand forecasting
• Liquidate slow movers
• Reduce order sizes
• Just-in-time where possible

Optimizing Working Capital

Step 1: Measure Current Position

Calculate:

• Working capital amount
• Current ratio
• Quick ratio
• Cash conversion cycle

Know your baseline.

Step 2: Identify Bottlenecks

Where is cash getting stuck?

• Slow-paying customers?
• Excess inventory?
• Early payment to vendors?

Focus on the biggest opportunity.

Step 3: Set Improvement Targets

Example targets:

• Reduce DSO from 45 to 35 days
• Increase inventory turns from 4 to 6
• Extend DPO from 20 to 30 days

Step 4: Implement Changes

For receivables:

• New collection process
• Tighter credit policies
• Payment incentives

For inventory:

• Reorder point system
• Slow-mover identification
• Supplier negotiations

For payables:

• Pay closer to due dates
• Negotiate extended terms
• Strategic payment timing

Step 5: Monitor and Adjust

Track metrics monthly:

• Are changes working?
• Any unintended consequences?
• What needs adjustment?

Working Capital and Growth

The Growth Dilemma

Growth typically requires more working capital:

• More inventory to support higher sales
• More receivables as sales volume increases
• May need to pay suppliers before collecting

Many businesses struggle or fail during growth because they can’t fund the working capital increase.

Planning for Growth

Before pursuing growth:

1. Calculate additional working capital needed
2. Identify funding source (profit, borrowing, equity)
3. Ensure working capital plan before aggressive growth

Working Capital Financing Options

When internally generated cash isn’t enough:

Line of credit: Flexible borrowing for working capital needs

Invoice financing: Borrow against receivables

Inventory financing: Borrow against inventory

Trade credit: Extended terms from suppliers

Equity: Owner investment or outside investors

Your Working Capital Action Plan

This Week

1. Calculate your current working capital
2. Calculate current ratio and quick ratio
3. Identify your cash conversion cycle components

This Month

1. Analyze each working capital component
2. Identify the biggest improvement opportunity
3. Set specific improvement targets
4. Create action plan for one component

Ongoing

1. Track working capital metrics monthly
2. Implement improvements systematically
3. Review working capital in quarterly business review
4. Adjust strategies based on results

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Need help managing your working capital? At Profit Path Books, we help small business owners understand their cash flow and optimize their working capital. Book a consultation to discuss your situation.