working capital

One reason your business is cash poor could be that you’re not managing the elements of working capital.  Listen to find out more..

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Show Notes

In this episode we will talk about the concept of working capital.  We’ll help you understand what makes up working capital and why you need to pay attention to it.  We’ll also give you tips on how to manage it better so that you are maintaining healthy levels for your business.

Key Points

*Working capital is a key element of liquidity that businesses need to fund operations and maintain momentum as it grows.

*Working Capital is current assets less current liabilities.  An asset or liability is current if is due within one year.

*Failing to watch and manage working capital can lead to potential problems of not paying its bills or meeting its obligations.

*While growing businesses are increasing sales, they are usually increasing spending which increases the pressure on working capital to stay ahead.

*Being profitable doesn’t necessarily mean that your business is free from potential working capital issues.

*We look at who in the company needs to be responsible to watch working capital.

*Lisa discusses the key positions in most businesses that have a role in impacting the elements of working capital.

*Entrepreneurs can help educate their team on working capital and how their decisions impact the company and its liquidity.

*Lisa gets into particular tips in managing and improving working capital on both the asset and liability side of the equation.

*One way to measure how you are doing in this area is to compute the working capital ratio.  Lisa describes how to calculate it and use it to monitor your business.

Resources and Links

Note: Links in this post may be affiliate links.  Lisa Roberts is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to

If you would like to contact Lisa for advice about working capital in your own business follow this link to request a Quick Care session.

To learn more about managing one of the elements of working capital be sure to check out this episode on Cash Flow Forecasting.

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Lisa Roberts is a business operations consultant who advises growth company entrepreneurs in successfully managing growth and the challenges they face along the way. She has over 25 years of experience in operations, finance and administration and spent several years in executive roles at a high growth company. She recognizes that there is a fine line between success and failure in a growing business and that entrepreneurs need to focus on managing finances, creating a sound operation and employ good business practices to stay on track.   You can find out more about her here

One of the bigger problems entrepreneurs face managing a growing company is having the amount of money you need to continue to grow and expand. It is often difficult to get the financing you need, when you need it. One of the most important things you need to pay close attention to is your liquidity and having the money you need to operate your business. A key component to measuring your ability to generate the funds and liquidity you need to operate your business in a healthy way is working capital.

Let’s take a look at working capital and look at the ways you can monitor, manage and improve it in your growing business.

Working Capital – What is It?

Working capital or the working capital ratio is a basic ratio to evaluate the short-term health of a business. It measures whether you can pay your bills, pay for assets like inventory and how long you can withstand a downturn and still meet your current obligations.

The working capital ratio is also known as the current ratio. To calculate take Current Assets divided by Current Liabilities. As an example let’s say you have current assets of $200,000 and current liabilities of $130,000.  Your working capital ratio would be 1.5 ($200,000 / $130,000).

Current Assets are things that can be turned into cash in a short period of time like accounts receivable, marketable securities, prepaid expenses, inventory, other liquid assets and of course cash.

Current Liabilities are short term obligations like accounts payable, accrued expenses and short-term debt.

What Should Your Working Capital Ratio Be?

Negative working capital is a ratio that is less than 1 and indicates that you do not have enough to meet your current obligations. A ratio over 2 suggests that you may not be investing your money well like having too much in inventory or not investing excess cash into investments that offer a better return for your business.

A good ratio would fall between 1.2 and 2.0 for most businesses and shows a good level of liquidity.

Managing the Big Three in Working Capital

There are things you can do to improve your working capital position and the most obvious is spending less than you take in. However, that’s pretty simplistic.  Of all the components of working capital, for many businesses the three biggies are Accounts Receivable, Accounts Payable and Inventory.

How can you make improvements in the Big Three to help improve your own working capital?

Accounts Receivable

When customers purchase “on account”, your business provides goods or services in exchange for a promise to pay later. While your business could avoid this by not allowing customers to buy on account, that is not always practical.  Here are 3 things you can do to manage working capital in accounts receivable:

  1. Set and consistently apply payment terms to customers that are reasonable. Keep in mind; if you have to pay your own vendors in 30 days, but you give your customers 60 days to pay, you are already 30 days behind in your cash flow position. Your goal is to set terms that allow you to convert receivables into cash as quickly as possible.
  2. Collect consistently. If a customer account is coming due, make sure you receive payment on time. Follow-up quickly on unpaid invoices. Be consistent in applying your collection policies to customers so they understand that they need to stay current in order to continue to do business with you. Remember, a sale is nothing until the cash is in your hand.
  3. Get payment sooner. You may be able to collect cash on a sale sooner by taking down- payments, progress payments, or offering small discounts for early payment.

Accounts Payable

The second item of the big three in working capital is on the liability side with payments due to vendors and suppliers in accounts payable. In this instance, your suppliers have allowed you to purchase “on account”.  Here are a few things you can do to improve working capital in accounts payable:

  1. Get the best payment terms you can and use them. Keep in mind what I mentioned under receivables, if you are collecting receivables every 30 days but you have to pay vendors in 15 days, you are behind 15 days in cash flow. Negotiate the best terms you can without incurring additional fees or charges and use the payment terms you’ve been granted. If you don’t have to pay for 30 days, then don’t pay in 10.
  2. Monitor what you spend with vendors. If you spend a large amount with one or two vendors, you may have some leverage to negotiate with them for a better price, volume discounts, shipping discounts or even longer payment terms.
  3. Consider early payment discounts. From time to time, a vendor may offer your business a discount if you pay before the normal payment term. This may make sense depending on your cash flow situation.

Inventory Management

The last item in the big three of working capital is inventory. Properly managing the amount you have in inventory can help you improve your working capital. Having too much in inventory can cost you working capital because money invested in unsold inventory isn’t making you money.  However, having too little in inventory may cost you money too – the cost of lost sales.  Here are some things you can do to manage your inventory better:

  1. Understand your inventory turnover. Inventory turns are how many times a year you sell items in inventory and have to replenish them over a period of time. Compare how your turnover rate is against your own industry and try to, at least, match the average for your industry. Carrying the right amount of inventory will help you improve working capital; having too much or too little can cost you.
  2. Maintain good inventory tracking. This involves not only tracking what you have but also what you need to replenish. In addition, having inventory clean, labeled and organized will help you avoid mistakenly ordering more of something you don’t need or getting caught with too little of an item.
  3. Understand and monitor your costs associated with inventory. Make sure that you understand and track costs associated with managing inventory. There are costs other than the cost of purchasing inventory that can add up. Here are a few to keep in mind: warehousing costs, shipping costs including expedite fees, slotting costs , obsolete inventory and losses due to theft.

It’s a good idea to have an emergency fund in your personal life and a good working capital position in your business. You will be happier and less stressed because your business will be healthier and able to withstand those dips and downturns that can sometimes set you back. Make sure that reviewing and improving your working capital is part of your monthly business management review.