Working Capital and Its Impact on Cash Flow

August 13, 2025

Written By Colin Napier

Consider this common scenario. You’re bringing in more sales, business is growing, and things should be getting “easier.” So why does it still feel like you have barely enough cash in the bank? This is a frustrating scenario that many business leaders face, and, in our experience, working capital is often to blame. No, it’s not the most glamorous concept, but it’s important you understand how it works, and how it impacts your day-to-day cash position, as this can make a big difference to the health (and growth!) of your business.

Learn more about Financial Management here.

Working Capital

In a nutshell, working capital is the money you need to keep your business ticking over day-to-day. To determine your working capital, you simply subtract your current liabilities from your current assets. Net Working Capital = Current Assets – Current Liabilities

Current assets:

Assets that can be converted into cash within a year, like cash and cash equivalents, accounts receivable, inventory and any short-term investments.

Current liabilities:

Obligations that need to be paid within 12 months, like accounts payable, short-term loans, accrued expenses and other short-term debts.

If the number is positive, fantastic, you have enough cash to continue operating in the short term. If the number is negative, it’s time to take proactive steps to ensure you remain solvent.

Working capital and its critical importance

Working capital is necessary to bridge the gap between paying your expenses (supplies, employees, etc) and getting paid by customers. If the gap gets too wide, and you don’t have sufficient funds to cover it, you can easily become cash-strapped – even when business is good. Through strategic planning and risk advisory, we help you anticipate funding gaps before they impact operations. Here, it’s important to understand that your net working capital must be funded by cash, either via equity or by borrowing money.

An Example Working Capital Calculation

Let’s say a business has the following working capital position:

Accounts receivable (Debtors): $250,000
Inventory: $300,000
Accounts payable: $150,000

To calculate working capital:

Current assets = Receivables + inventory
- $250,000 + $300,000 = $550,000

Current liabilities = Accounts payable
- $150,000

So, the net working capital is $550,000 minus $150,000 = $400,000. In this case, the business owner either has to contribute $400,000 in cash to fund the working capital shortfall or borrow the funds. Now let’s consider another example that we often see causing pain for growing businesses. Let’s say the above business increases by 20 per cent in the following year.

Accounts receivable increases by $50,000 to $300,000.
To cope with extra sales, inventory also increases by $60,000 to $360,000.
To offset these increases, we assume accounts payable increase 20% to $180,000.

All in all, working capital has increased by $50,000 + $60,000 – $30,000 = $80,000.

What’s the implication?

The $80,000 increase must be funded by managing cash somehow, either by reinvesting profits, the business owner injecting funds, or by debt. This situation can lead to a ‘cashflow crunch,’ which results in business owners coming to us in stress and confusion. “Sales are up by 20 per cent, but we have no cash!”

How to Improve Your Working Capital

Here are my top tips for improving the safeguarding of your working capital:

Speed up receivables collection:
- Provide early payment discounts and be vigilant on not letting debtors get beyond your payment terms. Also, consider whether you require upfront payments or deposits.
Keep inventory levels to a minimum:
- Optimise order quantities and minimise slow-moving stock wherever possible. Of course, the risk trade-off here is ensuring you have sufficient stock on hand to supply your customers, but the point is to be strategic and considerate with ordering.
Delay payables where possible:
- Negotiate longer payment terms with suppliers.
Sell any non-core assets:
- Sell unused or obsolete assets to generate cash.

Learn more about Strategic Financial Advisory here.

If your business is growing, you should also get an up-to-date cash flow forecast to determine if the growth is likely to result from a cash flow report. This way, you can take proactive steps to ensure sufficient cash is arranged to fund the required working capital. Understanding your working capital position is important. Not only is there a direct correlation to cash and cash funding requirements, but there’s also a funding cost to working capital. It requires either equity or debt, and if it’s debt, there is, of course, an interest cost. All businesses need to be aware that in times of high growth, or perhaps the addition of a big contract or project, working capital will increase and put strain on the cash flow of the business. By keeping a close eye on the components of working capital and implementing best practices to manage it, you can minimise the financial stress and associated costs. Get in touch if we can help get you on the right track. Colin

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