Glossary
working capital
Also called net working capital, working capital requirement
Working capital is the money tied up in the day-to-day running of a business: what customers owe you plus the stock you hold, less what you owe suppliers.
- How it's calculated
- Working capital = Current assets − Current liabilities
- In practice the parts that move are debtors (money owed to you), stock, and creditors (money you owe). A positive number means cash is tied up in the operating cycle rather than sitting in the bank.
Working capital is the reason a profitable business can be short of money. Every sale you make on credit is profit on the profit and loss and an absence in the bank until it is collected.
A worked example#
You buy £10,000 of stock and pay for it in 30 days. You sell it for £18,000 on 60-day terms. On paper you have made £8,000. In cash, you are £10,000 down on day 30 and only £8,000 up on day 60. For a month you are funding somebody else's purchase out of your own bank account, and if you double your sales you double that hole.
The three levers#
Collect faster, hold less stock, or pay later. Each frees cash without any change to profit, which is why working capital is often the quickest source of money in a business that is short of it. It is also why a forecast that ignores payment terms will be wrong about cash even when it is right about profit.