Working capital

Working capital is the difference between what the business owns that will turn into cash within a year, such as receivables, inventory and cash itself, and what it owes within a year, such as payables, wages, remittances and the current portion of debt. Operating working capital narrows it to receivables plus inventory less payables, which is the part that grows with the business.

It matters to a BC owner for two reasons. First, growth needs more of it, and a company that grows without planning the working capital finances the growth on its line of credit by accident. Second, buyers and lenders care about it. Most sale agreements include a working capital target, and a business that needs less working capital to run is worth more and closes with fewer adjustments. Lenders often set a current ratio or working capital covenant.

In practice, we measure operating working capital monthly, express it as a percentage of revenue so the trend is visible, and reduce the amount the business needs by shortening the cash conversion cycle. We also separate permanent working capital, which should be funded by equity or term debt, from the seasonal swing, which is what a line of credit is for. A line that is always drawn is a sign the two have been confused.