A business can be profitable on paper and still unable to pay its bills. The usual reason is working capital, the money tied up in the day-to-day running of the business. Stock waiting to be sold, customers who have not yet paid and suppliers who must be paid soon all sit in the working capital cycle. Understanding it, and managing it, is often the difference between a business that grows comfortably and one that is permanently short of cash.

What working capital is

Working capital is the difference between what the business owns in the short term and what it owes in the short term. Current assets include cash, bank balances, stock and money owed by customers. Current liabilities include money owed to suppliers, taxes due, wages and loan repayments due within a year. If current assets exceed current liabilities, you have positive working capital. A balance sheet shows both; see how to read a balance sheet for small business owners.

The cash cycle

Think of the cycle as a loop. You pay for stock, hold it until it sells, sell on credit, wait for the customer to pay, and meanwhile pay your own suppliers and staff. The time between paying out cash and getting it back is the cash conversion cycle. The longer it is, the more working capital you need. A shop that sells for cash and pays suppliers in thirty days has a short cycle; a wholesaler who carries stock for sixty days and gives customers sixty days to pay has a long one.

How to measure it

Three numbers tell you most of what you need:

  • Days of stock: how long stock sits before it is sold. Divide stock value by the cost of goods sold, then multiply by the days in the period.
  • Days to collect: how long customers take to pay. Divide money owed by customers by sales, then multiply by the days.
  • Days to pay: how long you take to pay suppliers. Divide money owed to suppliers by purchases, then multiply by the days.

Days of stock plus days to collect minus days to pay gives the cash cycle in days. The cost of goods sold monthly workbook and KPIs every small business owner should track show how to track them.

Why growth makes it worse

When sales grow, you need more stock and you extend more credit, so cash goes out before the extra sales bring it back. Businesses that grow quickly with thin working capital often run out of cash at the very moment they are most successful. Plan growth with cash in mind, using the 12-month cash flow forecast and cash flow forecast for a small business.

Release cash from stock

Reduce the stock you hold on slow lines, clear dead stock with promotions and order more often in smaller quantities. Use reorder levels so you hold only what you need; the reorder level and safety stock calculator helps. Count regularly and track what sells; inventory management basics and stock valuation for small shops give the tools.

Collect faster

Invoice promptly, set clear terms and follow up on overdue accounts. Ask for deposits on large orders. Offer a small discount for early payment if it makes sense. How to collect late payments from customers gives a process, and the aged receivables tracker shows who owes what and for how long.

Pay suppliers sensibly

Use the credit suppliers offer, but do not abuse it; paying on the due date, not before, keeps your cash longer. Negotiate better terms with reliable suppliers. Plan payment runs so you pay the right invoices at the right time; the accounts payable ageing schedule supports this.

Mind taxes and levies

Tax payments are part of working capital. VAT collected must be paid over, and PAYE and other deductions fall due monthly. Set the money aside as you earn it. The KRA filing calendar for small businesses shows the dates, and the monthly tax payments reminder sheet tracks them.

Financing the gap

If you still need more working capital, short-term finance such as an overdraft or a short loan may help, but it has a cost. Compare the interest with the gain; borrowing for your business: loans and tax and how to prepare your business for a bank loan application explain the options. Fixing the cycle is cheaper than borrowing to cover it.

Review monthly

Check your three measures each month and set targets: fewer days of stock, quicker collection, sensible payment. Small improvements add up to real cash. Managing working capital is not glamorous, but it keeps businesses alive.