What Working Capital is and How to Use it Effectively

Updated 24th July 2024

Working capital is an essential component of any successful business. It is the fuel that ensures ongoing day-to-day operations, pays for business expenditure, allows for ongoing investment and creates opportunities for growth.

But what exactly is it? Why is it important and how can you best manage working capital to help your business succeed?

Working Capital – what you need to know

In its most simple terms, working capital is the difference between your current assets and your current liabilities.

To break it down, your current assets are the resources that can be converted into cash within a year (generally). This can include cash itself, but also your inventory or stock, machinery and equipment, property, short-term investments and accounts receivable (i.e., the money owed by customers to your business).

On the other side of the ledger are current liabilities. These are financial obligations that need to be settled within a year (generally). For businesses, examples include accounts payable (i.e., the money you owe to suppliers), accrued expenses (like salaries payable), and short-term debt payments, such as business loans.

The amount of money you have left over when you take your current assets and subtract your current liabilities from it is your working capital.

Different Types of Working Capital

Generally, there are two main types of working capital.

1. Net Working Capital (NWC)

Net working capital is the most commonly used metric. It is the calculation we outlined above where one uses current assets minus current liabilities.

It is a simple calculation to understand in that a positive NWC indicates your business is financially healthy and a negative NWC indicates a financial issue.

2. Gross Working Capital

Gross working capital is also an informative metric.

This is simply the total value of your current assets. It doesn’t take into account one’s financial liabilities but it can be helpful to understand the overall resources available and inform specific strategic investment or growth decisions.

Why is Working Capital Important?

Working capital operates in many ways as a safety net for businesses. A healthy working capital level ensures your business has enough resources to meet relevant obligations and rise to opportunities.

There are short-term obligations in the form of expenses like bills, payroll and other operating expenditure.

But also importantly is to be able to seize opportunities and inavest in growth initiatives. This can include taking advantage of bulk discounts from suppliers, saving money through early payments or expanding into new markets when there is a clear gap in demand.

Critically, strong levels of working capital allow you to maintain good relationships with your supply chain. Having the financial ability to avoid late payments to vendors and maintain a positive reputation for stability instils confidence for ongoing transactions.

Working Capital Management Tips

Effective working capital management is an ongoing process. But there are some common and effective strategies for keeping your business ahead of the game.

Here are a few tips to get you started.

1. Monitor inventory levels

Closely monitoring your inventory levels ensures you have a strong understanding of your current assets.

This is important because having too much inventory ties up cash and increases storage costs.

2. Collect payments efficiently

It is also important to ensure you collect payments from customers efficiently. You can do this through more than just a robust accounts receivable department. Incentives for early payments, late payment fees, a clear collections policy and strong payment terms are all effective ways of managing the incoming cash flow side of the business.

3. Negotiate with your supply chain

It is important that you focus on both sides of the business process. Negotiating better payment terms with suppliers can help you extend your payment terms without jeopardising relationships or risking late payment. Bulk discounts and discounts for early payment are other opportunities for you to get ahead with your working capital management.

4. Track your financials

It is surprising how many small businesses do not closely and regularly track financial performance, including assets and liabilities. By analysing financial statements regularly, it is easier to track your working capital ratio and to identify trends, opportunities or problems.

How Can You Improve Working Capital?

There are several strategies you can implement to improve your working capital.

• Reduce inventory – streamlined manufacturing practices and implemented just-in-time inventory management can help free up capital elsewhere.
• Collect debt faster – offering online and easy payment options with early payment discounts can help you bring in receivables (money owed to you) faster.
• Longer payment terms – explore options with your supply chain such as consignment inventory or extended credit lines to easy up access to working capital in your business.
• Sell off slow moving inventory – consider getting rid of your slow moving inventory through discounts, promotions or liquidation sales.
• Explore working capital solutions – financial institutions, such as ScotPac, are experts in helping businesses find tailored financial solutions to ensure access to the working capital they need.

Finding Working Capital Solutions

If your business needs a temporary boost to access working capital, there are several financing options available. Our lending specialists will work with you to tailor each of these solutions to suit your needs.

Invoice Finance.

With invoice finance, you can ‘sell’ your outstanding invoices to ScotPac and receive an immediate cash injection. It allows you to access tomorrow’s invoice payments today.

Trade Finance

Trade finance ensures strong, collaborative and productive international trade agreements are established. If you are looking to cover import or export transactions, trade finance is often a necessity.

Asset Finance

Asset finance allows businesses to take advantage of and leverage their existing business assets, including equipment and property, to inject much needed working capital and ensure long-term success.

Business Loan

Both secured and unsecured business loans allow companies to improve cash flow and make strong strategic investment decisions.

Fuel your Business’s Growth with ScotPac

Whether you’re unsure which financial solution is right for you or just need advice regarding working capital management, our lending specialists are here to help.

ScotPac has over 35 years of experience, currently supports over 8000 businesses and funds

$27.3 billion in invoices annually. Unsure which funding solution is right for your business? Let us guide you.