Managing working capital: the essentials

Managing Working Capital: worker bees

Managing working capital: the essentials

Managing working capital is important to the success of any business. If you have already understood the importance of cash flow, then maybe it’s time to take stock of your working capital, or share the merit of managing working capital to your team. As a CEO or FD, it’s easy to let the financial management of your company be understood only by one department, so here we break it down for everyone to grasp. ‘Working Capital Management’ is a really powerful financial strategy that focuses on striking a balance between your company’s current assets and liabilities. It allows your business to not only cover its financial obligations, but also boost its earnings significantly. With working capital optimised, you can concentrate on running your business knowing that your financial position is supported in the best way possible way. Here are the essentials.


The benefits of healthy working capital

‘Working Capital’ typically includes inventory, cash, accounts receivable and payable, and debt due within 12 months. Having access to a healthy supply of working capital that provides cash, without tying up funds means more cash available for the wider benefit of the business.  And these benefits can be realised across the business. For example, supplier discounts due to prompt payment, optimised stock levels, the ability to tender for larger contracts, and offer increased credit terms for customers. Working capital is defined in the majority of cases as ‘the difference between current assets and liabilities’  e.g. net working capital, and so this is what this article describes how to manage efficiently.

The difference between working capital and cash flow

Working capital provides a snapshot of a business’s current net investment in operating assets, while cash flow refers to the amount of cash a company brings in and sends out within a specific period. Working capital therefore gives a more immediate but broad picture of a company’s ability to pay its liabilities, whereas cash flow is more of an ongoing, detailed measure.

Companies with a healthy net working capital position don’t always have a healthy cash cash flow, and vice versa – it depends on the profile of the current assets and liabilities, when stock is sold, when customers pay their bills and when the business itself needs to pay its creditors.

There are also “leakages” that reduce both surplus working capital and cash flow. For example, investment in new facilities or equipment, paying off long term debts or dividends to stockholders can be a drain on these.

Managing working capital

Working capital management is a focused financial strategy concerned with striking a balance between a company’s current assets and liabilities. An effective working capital management system allows businesses to not only cover their financial obligations, but also boost their earnings. This can be through reinvestment, or optimisation of processes.

Managing working capital involves managing inventories, cash, accounts payable and accounts receivable. It is the effective management of these components that determines what your working capital looks like and how much cash your business will have.

A large working capital surplus means that the assets of the company are more than enough to cover pending liabilities. Negative working capital means the company may not be able to pay upcoming bills with the amount of money, imminent receivables and other assets that can be converted into cash on short notice that it holds.

The most common method of ascertaining the working capital of a business is the Working Capital Ratio. The working capital ratio, which divides current assets by current liabilities, indicates whether a company has adequate short term assets to cover short-term debts and expenses. Analysing the working capital ratio, the inventory turnover ratio and the collection ratio will help a business to understand which areas of their strategy require focus for improvement.

Striking a balance

What is the right amount of working capital to retain within the business for optimal operational stability, liquidity and potential for growth?

The answer to this depends upon both the nature of the business but should generally be adequate to run business operations. Regular or permanent working capital should meet this level and should be generated by longer term sources. Temporary or flexible working capital usually fluctuates on a short-term basis and is generally used to cover seasonal or competitive peaks and troughs. This means it can often be higher than usual to cover these eventualities.

Although a healthy working capital position is generally considered more secure, an ongoing high level of working capital (generally considered to be a ratio in excess of 2.0) can be an indication of inefficient processes, and an inability to recognise and seize upon opportunities for investment and growth.

Decreasing or negative working capital is often a sign the company is or is becoming over leveraged and may be struggling. This means it is soon unable to pay its liabilities. The longer term result of this is bankruptcy.

Managing working capital deficits

A working capital deficit occurs when the current assets are insufficient to cover current liabilities. By running a working capital deficit you run the risk of not being able to pay short term creditors. This puts the business in a more vulnerable position.

When this happens, there a several options available.

  • A business overdraft
  • Short term loans
  • Increase / speed up debt collection
  • Reduce or defer operational expenses – cut costs
  • Agree a delay in payments out to creditors
  • Convert other assets to cash, i.e. stock


However, these should generally be seen as a short term solution for what might be a longer term problem. Short term lending or delays in payments are not a replacement for a structured working capital strategy. Haphazard, ill-managed collection drives are also unlikely to achieve any long-term results, and may alienate customers. Developing a strategic approach to collection based upon the key supply chain drivers is essential. More on this later.

Managing working capital surpluses

There are of course times when your business may accumulate an excess in working capital. Rather than allow current assets to remain large unnecessarily, you should put them to work for your business by releasing the cash to do other things with. Your main options are:

      • Pay down outstanding debt
      • Short term, low risk investment
      • Secure volume discounts by buying extra stock. There can be disadvantages to doing this as it ties up available cash, so look carefully at this first

Managing working capital – tips for success

In order to maintain healthy, balanced working capital, there are a number of essential areas that require constant management as part of an ongoing working capital optimisation process.

1. Forecast your requirements

Striking a balance between keeping adequate working capital to cover liabilities, and ensuring profits are not dampened by excessive tied costs requires a thorough understanding of your finances. Key to this process is forecasting. Using the annual budget as a stepping off point, forecasting involves predicting the timing of both cash collection and payments. Being able to accurately forecast your liabilities and future cash position is fundamental to understanding your working capital requirements.

Within your regular forecasting you should include:

      • Future anticipated levels of receivables, and payables
      • Future stock based on predicted trading levels and historic holding periods
      • Items of capital expenditure e.g. purchase of assets or acquisitions
      • All current cash balances (including amounts in the business bank accounts)
      • Any other asset and liability related cash flows such as tax payments
      • Contingency


The benefits of clear and accurate forecasting that it enables you to:

      • Have a clearer picture of your working capital requirements
      • Look at the cash flowing in and out of the business
      • Assess future cash and funding requirements
      • Put appropriate facilities in place to meet working capital requirements down the line
      • Examine the available options and choose one that most suits your business
      • Have lenders easily assess your request for funds
      • Demonstrate good financial management


2. Optimize your cash conversion cycle

Businesses don’t fold because they don’t have profits. They fold because they don’t have cash.”
– John Mardle, expert in working capital optimisation and Managing Director at Develin & Partners

In order to retain a healthy working capital position, you must keep the business succeeding. And it’s not just about making the sales. Collecting the cash is what matters. Optimising your cash conversion cycle to ensure cash enters and leaves your business in a way most beneficial to its operations is crucial to maintaining strong working capital.This addresses the whole of the order-to-receipt cycle of the business, which is:

Customer acquisition and retention

Credit check all new customers and put contracts in place with clear terms.Keep an eye on current customers and look for indicators of trouble. Communicate with them quickly. If there is an issue, reduce credit or ask for payment in advance for future orders.

Order and fulfilment

Proper fulfilment of customer orders is a critical.The faster goods or services can be supplied, the quicker an invoice can be raised and cash collected.


These must be clear, accurate and uniform. No mistakes and no vague terms.


Efficient, firm, and well-communicated. A clear escalation procedure. Don’t let debt get overdue before identifying potential disputes and contacting late payers.

3. Optimize your supply chain

Managing your supply chain is another essential element to developing a robust working capital management strategy. Assessing your needs based upon the below drivers will help you decide how to approach your suppliers when it comes to managing working capital deficits or gaps.

      • Price
      • Certainty of supply
      • Product Quality

4. Optimize your stock for demand

Holding too much stock is not necessarily a good thing as it can’t always be liquidated quickly in times of cash strain. Gearing your business model and stock inventory to customer demand is more efficient and logical than gearing it to something more uncertain such as sales projections.

Seasonal businesses may need to reassess their asset requirements regularly in order to avoid insufficient stock levels and order fulfilment failures. Alternative finance facilities are specifically designed to assist seasonal businesses with fluctuations in working capital requirements to due peaks and troughs in demand.

5. Get cross-company buy-in

Get support for working capital improvements by linking compensation to cash flow and working capital metrics. For most managers, compensation is a more effective driver than a company ethos.

According to John Mardle, it is a mistake to believe that working capital management is an issue for the finance department only. The levers that most directly impact working capital are operational in nature. Working capital management must extend beyond the finance department and engage the company’s entire managerial team.

6. Communicate with stakeholders

Once you identify a future problem, you should meet with your bank and other stakeholders as early as possible to explain your situation and agree a solution.

Tactics to Avoid

1. Investing too heavily in current assets (stock and debtors)

Holding too much stock is not necessarily a good thing as it can’t always be liquidated quickly in times of cash strain. Giving too much credit puts a strain elsewhere on the business, for example reducing cash, increasing borrowing or increasing credit taken from Trade Creditors

2. Delaying payments to major suppliers

This may help working capital over the short term, but that improvement is likely to be negated over time as vendors adjust their pricing accordingly Once you become a late payer, your bargaining position is compromised. Instead, use your leverage as a good customer to your advantage. This is where a supplier payments finance facility like Pay4’s can really come into its own.

3. Reducing inventory without supply chain optimisation

There is a direct correlation between inventory management processes and customer service. Reducing inventory without addressing these core processes will cause customer service to degrade.

The role of supplier payments finance

Running a healthy working capital surplus puts your business more in control. Supplier payments finance facilities provide additional working capital early in the cash flow cycle. They are designed specifically to optimise working capital for growth and ease cash flow pressures. They allow businesses to ride the peaks and troughs of demand and allow owners to think more strategically in terms of how they use the working capital resources available to them. If you are a UK company that has been operating for 2+  years contact us to find out how Pay4 can help you manage your working capital.