What is Working Capital Management?

Sole Trader Services

It’s true you are in Business to make a profit but a big mistake that so many new Business Owners make is to ignore their Cash Flow requirements and Working Capital Management.

Working Capital

Working Capital is defined as the assets of the business that are used for day to day operations, some elements of working capital are relatively liquid and can be quickly liquidated to cash while others may have a longer lead to becoming cash.  The ability for a company to turn its Working Capital into cash in a timely manner to cover debts could be the difference between surviving in business and not.  After all if you can’t pay your suppliers and other bills when they become due this could quickly spiral out of control resulting in insolvency and bankruptcy.

There’s no magic formula for the level of Working Capital you should maintain it’s largely dependent on the Business size and in the industry it operates.  Generally though it is wise to maintain a positive balance of Working Capital – this is defined as a higher balance of Current Assets against Current Liabilities.  Current Assets are your sources of cash while Current Liabilities are your drain on cash.

Generally your Working Capital is made up of your Current Assets less your Current Liabilities as follows:

  • Stock
  • Debtors (Customer outstanding balances)
  • Bank
  • Cash


  • Creditors (Supplier outstanding balances)
  • Overdraft
  • Short Term Loans & Leases

Let’s take stock as an example – assuming your stock is raw supplies that you have yet to process and it will take 15 days to process your stock into a finished item for resale, once finished you must then sell the item to a customer (assume this takes a further 10 days).  Your customer may then dictate a line of credit with you of 45 days so this again has to be considered.  In short to turn your stock into cash you are looking at (15+10+45) 70 days.  Imagine you had no Bank or Cash balances in this example and your HMRC tax bill was due for payment within 30 days – how would you fund your tax bill?

This example shows the importance of Cash Flow and Working Capital Management, your business could be highly profitable but if you don’t have a sufficient flow of cash to satisfy debts as they become due you could find yourself in a tricky situation.

Management of Cash Flow

The production of regular Cash Flow statements will help with the management of your Cash Flow, they will highlight any shortfalls early in the process allowing you to arrange for additional finance to cover any payments due.  A good Accountant can prepare a regular forecast for you or give you guidance on preparing one for yourself.

Once you have a ‘picture’ of your cash situation you can them implement plans to improve your Working Capital.


Holding stock can be necessary to meet sales as they become available however holding excessive levels of stock can result in tying up cash that could be earning a return elsewhere.  From the above example you will see that Stock holding can take some time to convert to cash as it must be processed, sold and then payment settled by your debtors.

Generally when looking at stock levels if you hold 300 units of stock but on average only sell 75 units a month then you are holding 4 months (300/75) worth of stock.  If your sales level is relatively consistent and stock can be replaced reasonably quickly then this level of stock holding for your business may be excessive and wasting valuable cash.


Debtors are your customers that you have allowed a line of credit on their purchases, allowing credit is useful as it will attract more customers, however you must ensure you keep control of the credit taken.  In many industries the level of credit you offer may to some level be dictated by the levels offered by your competitors, as if your competitors offer the same products at the same prices but offer better credit terms than you – they will likely get the business.

What you must however remember is that when you offer credit to your customers you are in effect offering them a free bank loan for the term of the credit.  You could be using your cash (that has been tied up with your debtors) to earn a return in other ways.  Therefore although it is beneficial to offer credit (once customers have been thoroughly credit checked!) it is wise to entice those customers to settle their bills quickly.  This can be done by offering a prompt payment discount or an interest levy on balances overdue.

In addition to this you should set and agree the credit terms in advance with your customers and set-up an efficient credit control system to ensure those debts are settled within the agreed payment terms.

Bank & Cash

Bank and Cash balances are both relatively liquid, you may have some bank accounts that tie your money in for a number of months or even years but generally you can withdraw from even these accounts only losing the accrued interest.

The disadvantage of high Bank and Cash balances is that in today’s world you tend not to earn a significant return on your funds, they may be better utilised and invested in other areas.  It is however a balancing act – what level of assets do you maintain liquid (eg Cash and Bank) to cover impending debts but do not waste the opportunity of investing for a higher return.


These are your suppliers that offer you a line of credit, in essence they are funding your purchases by offering you a free bank loan for the term of the credit.  The longer the credit term they offer you the better as you will in effect have use of their money to invest elsewhere.  It is wise not to abuse the credit facility offered by your suppliers as they will quickly withdraw the credit forcing you to pay upfront for any purchases and this may have a detrimental effect on your business.


To recap Cash is the life blood of any business without it businesses could not trade and operate.  Staff and suppliers would not be paid and work would stop!  Although you may be in business to make a profit you must also keep a close eye on your cash balances and your cash situation.  Especially in cases where you are planning an expansion for your business – your working capital requirements will be essential in these circumstances.

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