In a perfect world, you would sell stock or provide a service one day and get paid for it at the same time. If there were no lag between money out and money in, there would be no need to hold funds within your business to make the next sale or to cover expenses like wages, rent and tax. In the real world, of course, every business needs a pool of cash on hand to bridge the gap. This pool of money available to fund day-to-day operations is known as working capital and is the lifeblood of every business.

Working Capital is calculated by subtracting your current liabilities from your current assets.




What are Current Assets and Liabilities?

Current assets are things the business owns or has a claim on, and that can be rapidly turned into cash – think inventory and accounts receivable (‘current’ usually means within one year).

Current liabilities are obligations that will soon fall due – think short-term debt and accounts payable.

If your working capital is positive when using the Working Capital formula current assets – current liabilities, your business has enough working capital to keep operating, even if conditions tighten up for a while.

As Working Capital is the difference between your assets and liabilities, the higher the working capital the better it is for your business. 

The amount of working capital a business needs varies throughout the year and it is important you have enough working capital to sustain your business all year round. In order to ensure that you have enough working capital it is a good idea to assess your working capital monthly and quarterly not just yearly.


Calculating your Current Assets

The main figures that will make up your businesses current assets are your cash at bank, stock value and the debtors (also known as accounts receivable). If we add these three figures up we will get a good idea of your current business assets to use in your working capital.

If you have $20,000 cash at Bank, Stock valued at $50,000 and $50,000 in Debtors, your current business assets adds up to $120,000


Calculating your Current Liabilities

The main figures that will make up your businesses current liabilities are your creditors (also known as accounts payable), your payroll (also known as wages), taxes and other running costs such as monthly subscriptions, rent or mortgage repayments (depending on whether you own or rent your business premises). Assume that your total creditors, payroll and other running costs add up to $100,000.

You can now calculate your working Capital using the Current Assets – Current Liabilities formula. 

So if you have $120,000 in Current Assets and $100,000 in current liabilities, your working capital is $20,000

Although a very useful calculation the working capital formula on its own will not provide a full understanding for your businesses working capital. We also need to look at the “operating cycle” (also known as the “Cash Conversion Cycle”)


Calculating Your Business’s Cash-Conversion Cycle

In order to calculate your businesses cash conversion cycle you will need to first understand your businesses Inventory Days, Debtor Days and Creditor Days.

Inventory days are the number of days that stock sits on your shelf before it is sold or the number of days your business has to pay for labour and materials to create a saleable product.

Debtor Days are the number of days it takes your business to collect payment from their customers while creditor days are the number of days your business can wait before it must pay its creditors.

Your businesses Cash Conversion Cycle is calculated by adding up the inventory and debtor days and subtracting the creditor days from the result.



In the case where a business has 55 Inventory days, 45 debtor days and 30 creditor days, The cash conversion cycle is calculated to be 70 days. 

i.e. Cash Conversion Cycle = (55 Inventory Days + 45 Debtor Days) – 30 Creditor Days = 70 Days

In this example it takes the business 70 days for the business expenditures to return to the business as cash

The Cash Conversion Cycle can be lengthened if sales suddenly slow down or alternatively it can be shortened by decreasing the number of debtor days. So, once you have calculated your Cash Conversion Cycle it is a good business strategy to work on shortening the cycle and decreasing the number of days your business has to wait to recover its costs.

By understanding your business’s working capital requirements, you can help shorten your cash-conversion cycle and plan for times of business stress.

If, after you’ve crunched the numbers, you fear your business may be a little short on working capital, rest assured there are finance options available.

Contact us or submit your details now to find the right Business Finance solution to help you manage your working capital needs and grow your business.