Key takeaways
- Working capital is the difference between what your business owns and what it owes in the short term.
- A longer working capital cycle can even strain a profitable business.
- Collecting from customers faster and using your supplier terms well can free up cash.
- Even well-run businesses face gaps. A business overdraft can help you cover them.
What is working capital management?
Working capital management is how you track and improve your short-term financial position. The aim is to meet your short-term bills while you keep the business running and growing.
It’s linked to cashflow management, but it isn’t the same thing. Cashflow is about money moving in and out. Working capital is about what you have on the balance sheet at a point in time. We’ll come back to that in the FAQs.
How to calculate your working capital
The formula is simple:
Working capital = current assets - current liabilities
Current assets are things you can turn into cash within a year: cash in the bank, money customers owe you (receivables) and stock.
Current liabilities are what you owe within a year: supplier bills (payables), short-term debt and accrued costs, like wages or tax you haven’t yet paid.
Here’s an example. Your business has £120,000 in cash, receivables, and stock. It owes £80,000 in bills and short-term debt. Your working capital is £40,000.
You may also hear about the working capital ratio. You work it out by dividing current assets by current liabilities. In our example, that’s £120,000 divided by £80,000, which would give you a working capital ratio of 1.5.
This example is for illustration only.
Understanding the working capital cycle
The working capital cycle is how long it takes to turn the money you spend into the money you receive. It works like this:
- You spend cash on inputs, like materials or stock.
- Those inputs become goods or services.
- You sell on credit.
- Your customers pay you.
- Cash comes back into the business.
The longer that loop takes, the more strain it puts on your cash. A business can be profitable on paper and still run short, because the money is tied up between steps two and four.
How to optimise your working capital
Once you know your position, you can improve it. Two practical places to start:
- Speed up your debtor collections. Set clear payment terms on every invoice. Run credit checks on new customers. Send automated reminders. Follow a consistent process when an invoice becomes overdue.
- Make the most of your trade credit terms. Agree clear payment terms with your suppliers, and use the full time they give you. That shortens the gap between paying out and getting paid.
When working capital finance can help
Good working capital management can make a big difference. But even well-run, profitable businesses face temporary gaps. Improving your cycle isn’t always enough on its own.
It tends to happen when:
- Your income dips for the season.
- You’re waiting for a large invoice to be paid.
- You’re spending ahead of a new contract.
- You get an unexpected cost and you don’t want it to disrupt day-to-day operations.
That’s where working capital finance comes in. Using it isn’t a sign your business is in trouble, instead it’s practical tool that works alongside good management. Read more about how a working capital loan works.
A business overdraft is one of the most flexible options. You only pay interest on the amount you use. You can use it and pay it back as often as you need. It suits ongoing or unpredictable cash flow swings better than a fixed, one-off need.
How Allica Bank can support your working capital needs
If you’re an established business, our business overdraft gives you flexible cashflow support. You can put it in place before you need it, then use it when the moment comes.
You pay interest only on what you use, and a 1.5% arrangement fee applies to your agreed limit. You can borrow from £25,001 up to £2 million. You’ll need a Business Rewards Account as your main business account.
If you’d like to see how it works, take a look at our business overdraft.
All lending is subject to status, our lending criteria, and a satisfactory credit assessment. Terms and conditions apply. Overdrafts are repayable on demand.
Frequently asked questions
What is a good working capital ratio for a UK SME?
There isn’t one right answer. A good ratio varies a lot by sector, business model and how fast you’re growing. A business with predictable income might need less of a cushion than one with seasonal sales.
What is the difference between working capital and cash flow?
Working capital is a balance sheet measure of your current assets minus your current liabilities at a point in time. Cashflow measures the movement of money going in and out of your business over a period.
What is the difference between a business overdraft and invoice finance for working capital?
Both can bridge a working capital gap, but they suit different situations. An overdraft gives you a flexible limit you can use and repay as you need to, so it suits unpredictable or recurring gaps. Invoice finance releases cash against your unpaid customer invoices, so it suits businesses with large debtor books waiting to be paid.
Links were live and information was correct at the time of writing the article.
Disclaimer: This is information – not financial advice or recommendation.
The content and materials featured in this article are for information and education only, and are not intended to take into consideration any particular recipient’s financial situation. The product details referred to are correct at the time of writing. The information does not constitute financial advice or recommendation and should not be considered as such.
