What is working capital?
Working capital is the money available to run day-to-day operations, worked out as current assets minus current liabilities.
What working capital means
Working capital measures the cushion a business has to pay for its everyday activity. Current assets (cash, stock and money owed by customers) are what you expect to turn into cash within a year. Current liabilities (supplier bills, VAT, PAYE, short-term loans) are what you need to pay within a year. The difference is your working capital.
Positive working capital means you can cover short-term obligations. Negative working capital means you depend on new sales or borrowing to pay bills that are already due.
The formula
Working capital = current assets − current liabilities
Both figures come from the balance sheet. Related to it is the working capital cycle: the number of days between paying for stock or labour and receiving cash from customers. The longer that cycle, the more working capital you need.
Example
An online clothing brand has:
| Current assets | Current liabilities | ||
|---|---|---|---|
| Cash | £15,000 | Suppliers | £22,000 |
| Stock | £40,000 | VAT due | £9,000 |
| Marketplace payouts due | £5,000 | Credit card | £4,000 |
| Total | £60,000 | Total | £35,000 |
Working capital is £25,000. But £40,000 is in stock. If the brand orders a large autumn range on 30-day terms and sales are slow, it could struggle to pay suppliers even though the balance sheet looks positive.
Why it matters for your business
Growth uses working capital. More sales usually mean more stock and more customers owing you money before the cash arrives, so a fast-growing business can run short of cash while its profits rise. Understanding your working capital tells you how much funding growth needs and whether an overdraft or invoice finance would help.
How to improve it
- Invoice promptly and shorten payment terms for debtors
- Hold less stock and reorder more often
- Negotiate longer terms with creditors
- Use finance for equipment rather than paying from cash
- Set money aside monthly for VAT and Corporation Tax
Working capital when you grow
Suppose sales grow by 30% and customers keep paying on 45-day terms. Debtors grow by 30% too, and so does the stock you need to hold. That extra money has to be found before the extra profit arrives. Many businesses that fail while busy have simply run out of working capital. Planning the funding before a big contract or a seasonal peak, through an overdraft, invoice finance or retained profit, avoids the squeeze.
Common questions
Not always. Supermarkets and some subscription businesses collect cash from customers before paying suppliers, so they run with negative working capital safely. For most small businesses, though, negative working capital is a sign that bills may soon go unpaid and needs attention.
Enough to cover your working capital cycle comfortably, plus a buffer. A common rule of thumb is a current ratio between 1.2 and 2, or two to three months of overheads in accessible cash. A cash flow forecast shows the real figure for your business.