Working Capital Management

What is working capital?

The formal definition of working capital is “…capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities…”. It is a measure of the cash resources available to the business for its day-to-day operations and repayment of short-terms debts. You may think of it as a comparison of what the business owns vs what it owes in the short-term (usually within a 12-month period).

Working capital management is therefore concerned with the business’s short-term liquidity, and how quickly it realises cash from its day-to-day normal trading activities. It is a decision-making process which has the objective of ensuring the business has enough cash resources (or short-term assets easily convertible to cash) to repay its short-terms debts and fund operational expenses. Arguably because cash is king in a business, it is ideally preferable that trading converts into cash as soon as possible, however this all depends on the business model and the nature of trading activities. It is also ideal that a company has a positive working capital balance at any given point in time, meaning that it owns more that it owes, and is therefore able to repay its short-term liabilities as they fall due.

The best measure of how effective a business’s working capital management is would be to work through a “working capital cycle”, discussed below…

Working capital cycle

This is the flow of cash through the business and how it is converted through trading operations, with a calculation of the average time from when cash leaves the business to when it is returned back through trading. The cycle can be traced as follows (e.g. for a company buying and selling goods):

  • products are bought on credit from supplier (creditors) ——>
  • supplier chases company for amount due and company pays supplier (cash out) ———>
  • products are held until a customer is found (stock) ——–>
  • customer is found and products are sold to them on credit (debtors) ——–>
  • company chases customer for amount due and customer pays for products sold (cash in) ——>
  • Then the cycle begins from the top again.

As can be seen from above, there are 4 main components in the cycle:


Stock (Inventory),

Debtors, and


The management of the cycle ensures that the time period between the “cash out” and the “cash in” is as short as possible. For businesses that are predominantly cash-based (e.g. supermarket chains), cash is received at point of sale therefore there is very little time between the sale of goods and the receipt of cash for the goods. Consequently, for these types of businesses, the cycle is very short and there is almost always cash available to pay back suppliers. When we tip to the other side of the scale (e.g. construction companies), the cycle becomes longer as the sales are usually on credit, and cash-in is not recognised until some time (e.g. 30 days) after the sale, and therefore management of working capital is crucial in terms of keeping track of the goods sold and retrieval of monies due from customers, whilst ensuring creditors are paid on time for monies owed to them. It is also crucial to perfect the management of the stock when it is being held before finding customers to sell to, as so to minimize loss of stock through damage, obsolescence or theft. There are, of course, businesses that do not hold any stock (e.g. services companies such as IT contractors, accountants, lawyers, etc). Despite holding no stock, services companies still require effective management of their working capital to ensure that the services they provide ultimately realise monies in, preferably as soon as possible.

Importance and advantages of working capital management

As explained above, an effective management process is crucial to ensure that the business has enough funds to settle their short-term liabilities and to make sure business is running as smoothly as possible without disruptions caused by shortages of cash. Working capital management is more concerned with the availability of enough “cash” for continued operational success of the business, rather than concerns  on profitability. For example, a business might report very high profits in its profit and loss statements from trading, however with very low (or even negative) cash reserves to support continued profitability and success. Unless the business devotes enough attention to ensuring an effective working capital management process is in place, the high profits it reports might not be recognised through the hard evidence of cash.

The more obvious advantages of having a policy around managing working capital are (this list is not exhaustive):

  • the process ensures that there is enough cash for a smooth continuation of business operations and the repayments of short-term debts, which avoids the business from going under.
  • assists management in making decisions around improving and maintaining the processes in place for doing business and avoiding failures.
  • the profitability of the business in the long-run is improved as an improvement in the management of cash would breed more efficient business trading and ultimate growth.
  • facilitates for planning around any extra cash in the business being made to better use, e.g. consideration of investing and realising other income. Therefore, the cash available could be diverted more to long-term use.

Components of working capital

As working capital can be broken down into 4 main components, we will analyse each of these components over 4 articles, looking at how to implement policies in each, for overall effectiveness of the whole process. Each of these articles will break down the various “sub-components” within each component, and provide any recommendations for an optimal management process, whilst also informing of the various tools that Invicta can provide that are at your disposal. Please watch this space for further articles.

What can Invicta do for you?

Invicta uses cloud-based accounting software for record-keeping and reporting, which a crucial part of managing a business’s working capital. Information is recorded accurately in our software, access to which is available at any time. We are accountants who make use of the various working capital ratios and analyses to provide you with relevant information for effective decision-making relating to your business’s working capital. We can provide you with advice on the best accountancy practices on the various components of working capital, including relevant policies that suit your line of business. Call Invicta Accounting on 01624 672358 or emails us at for more information, and be sure to refer to next 4 upcoming articles for more detail on the various components as discussed above.