2 min read
What working capital is and why it matters
Working capital is the net of current assets (debtors, stock, cash) minus current liabilities (creditors, VAT due, short-term borrowing). A positive figure means the business has a buffer to absorb short-term fluctuations; a negative figure means current obligations exceed liquid assets, which creates immediate pressure on cash.
Even profitable businesses can be destroyed by working capital problems. If customers take 90 days to pay but suppliers demand payment in 30 days, the business must bridge a 60-day gap from its own cash reserves or borrowing facilities. During a period of rapid growth, this gap widens fast — a phenomenon known as overtrading.
The cash conversion cycle
The cash conversion cycle (CCC) measures how many days it takes for the company to turn a pound of input cost into a pound of cash received. It is calculated as: days inventory outstanding (DIO) + days sales outstanding (DSO) − days payable outstanding (DPO).
A shorter cycle means less cash is tied up at any moment. A manufacturer holding 60 days of stock, invoicing customers who pay in 75 days, and paying suppliers in 30 days has a CCC of 105 days — meaning it must finance 105 days of cost from its own resources before recovering cash. Reducing DIO or DSO, or extending DPO through negotiation, directly improves cash generation.
Managing debtors and creditors
Trade debtors (your customers' unpaid invoices) are often the largest drain on working capital. Practical steps include issuing invoices promptly, setting clear payment terms in contracts, following up systematically at and beyond due date, and considering early payment discounts for customers who settle quickly.
On the creditor side, extending supplier payment terms where commercially acceptable preserves cash. However, stretching creditors beyond agreed terms damages supplier relationships, can trigger credit restrictions, and may affect your company's credit rating. The goal is a sustainable balance, not simply delaying payment as long as possible.
Stock and work in progress
For businesses that hold physical stock or have significant work in progress (WIP), these balances represent cash that has been spent but not yet converted into revenue. Excess stock ties up capital unnecessarily; insufficient stock risks lost sales. A regular review of slow-moving, obsolete or overstocked lines — and a clear write-down policy — keeps the balance sheet honest and frees cash.
- WIP is particularly significant in construction, professional services and manufacturing
- Over-cautious stock levels to avoid stockouts can be just as costly as excess stock
- Stock financing facilities exist specifically to fund raw material and finished goods cycles
- A sudden rise in stock relative to revenue may indicate slowing sales or a fulfilment delay worth investigating
Frequently asked questions
What is overtrading and how does a director spot it?
Overtrading occurs when a business grows faster than its working capital can support — revenue is rising but cash is being consumed. Signs include a rapidly shrinking cash balance despite rising sales, increasing overdraft use, and difficulty paying suppliers on time even when the P&L looks profitable.
Can working capital be financed externally?
Yes. Invoice discounting, factoring, stock finance and revolving credit facilities are all designed to fund working capital cycles. They provide liquidity against existing assets rather than introducing permanent debt — illustrative of how commercial lenders approach short-term funding needs.
Funding for UK limited companies
Credicorp lends to your company, not to you personally — short-term working capital with no personal guarantee. See what your business could access.