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Working Capital Management: The Essential Guide

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Running a business requires effectively managing the money your business earns and spends. You want to keep operations running smoothly with an eye toward growth while improving profitability.

There are several key metrics to help manage your company’s financial performance. One of the most important metrics to watch is a company’s working capital, which refers to the money your business spends on operational costs.

We can help you understand what it takes to develop and implement an effective working capital strategy and your options for financing help when you have working capital shortages. Specifically, we’ll answer these questions and more:

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    What is Working Capital Management?

    Working capital management refers to the practice of efficiently tracking, reporting, and adjusting a business’s use of its current assets and liabilities to ensure optimal financial performance. Before diving into the specifics of how to manage working capital, let’s cover what it is and why it’s important.

    Working capital refers to the money used to cover the daily operating costs of your business. It includes the costs of inventory, supplies, and goods. It also includes overhead costs such as payroll, rent, and utilities.

    To calculate your working capital, start with your company’s current assets, which refers to highly liquid assets such as cash, inventory, and accounts receivable. Do not include fixed assets like real estate or equipment.

    Next, calculate your current liabilities, including accounts payable, taxes, loan interest, loan principal due within one year, deferred revenue, and other accrued expenses. Then, subtract your current liabilities from your current assets:

    Current assets – current liabilities = working capital.

    An effective working capital management strategy ensures a company always has enough cash or cash equivalents to meet its short-term financial obligations. It helps maintain the smooth operation of the cash conversion cycle.

    How does Working Capital impact your company’s financial health?

    Many businesses use the working capital ratio, also called the current ratio, as a metric to track their working capital usage. Divide your current assets by current liabilities to determine your current ratio.

    A working capital ratio of 1.0 means your company can meet its financial obligations but won’t have the cash to cover investments, growth, or unexpected costs. A current ratio below 1.0 means your business will struggle to make payments for expenses or taxes. This is also known as negative working capital. If your business remains in a negative working capital situation, it may eventually be forced to shut down.

    Current ratios above 1.0 indicate a positive working capital situation. Ratios between 1.2 and 2.0 are considered ideal because you have enough cash to cover expenses while investing in growth. However, ratios above 2.0 may indicate your business is not properly utilizing its assets to drive new revenue.

    What is Working Capital vs. Net Working Capital?

    Working capital and net working capital are synonyms, but some businesses use a more focused approach for calculating operational capital. One more narrowed method includes removing cash and debt from the equation:

    Current assets (less cash) – current liabilities (less debt) = net working capital.

    An even more narrowed view only calculates accounts receivable, inventory, and accounts payable:

    Accounts receivable + inventory – accounts payable = net working capital.

    What are the key principles of Effective Working Capital Management?

    Several key components go into effective working capital management.

    Managing Liquidity

    Managing working capital includes ensuring your business has the cash resources to pay for business needs. If too many of the business’s resources are tied up in illiquid assets, it may have difficulty maintaining cash flow or paying short-term debts.

    Managing Accounts Receivable

    Tracking your accounts receivable is essential in understanding and predicting your working capital availability. You should keep track of several ratios when managing your accounts receivable.

    • Collection ratio: Also known as Days Sales Outstanding (DSO), this ratio measures a company’s efficiency in collecting payment from outstanding invoices. To calculate the average collection period, divide the average total accounts receivable during an accounting period by the total net credit sales and multiply the quotient by the average number of days in the cycle.
    • Aging report: This is a metric that helps you keep track of when invoices are due and past due. You can use this metric to help send timely reminders for accounts due.

    Managing Accounts Payable

    Accounts payable (AP) refers to money your company owes to vendors, suppliers, contractors, or other businesses. Managing your AP is vital because late payments could increase costs and damage your relationship with the companies your business relies on to get inventory, supplies, maintenance, and more.

    Managing Short-Term Debt

    Paying off your company’s debts from short-term financing is important to avoid late penalties and damaging your business credit. You may need additional short-term or long-term financing in the future and want a positive payment record. One of the key ways to do this is to ensure your using the short-term financing programs best suited to your business’s cash flow cycle.

    Managing Inventory

    Inventory is the primary asset your business uses for sales revenue. You want to ensure you have enough inventory in stock to meet customer needs but not so much inventory that too much of your liquidity is tied up in assets that won’t move for a while. Track your inventory turnover ratio and cost of goods sold (COGS) to measure your inventory efficiency.

    What are the benefits of Working Capital Management?

    An effective working capital management strategy provides critical insights into your company’s financial performance and efficiency. It can help you identify areas where your business excels and where you can improve.

    It keeps you on top of payments coming in and going out. Tracking payments due assists you in ensuring you have enough cash on hand to pay for your company’s short-term obligations. An effective strategy gives you more tools to maximize your inventory purchases and management to reduce turnover.

    Using working capital management best practices provides insights to balance short-term and long-term debt in the most effective ways possible. It can also help you avoid late payments for accounts payables.

    What are the limitations of Working Capital Management?

    Working capital is a vital component of financial analysis, but it can’t give the whole picture. Most businesses should use multiple metrics and tracking tools to analyze finances for a complete picture of a company’s performance and future projections.

    For example, working capital management cannot predict future financial outcomes. Market conditions, branding, competitors, and market saturation are all components you must balance outside of managing your working capital.

    It also doesn’t improve or guarantee profitability. It can’t increase market demand for your products or services, bring in new customers, or help retain existing customers. To improve the bottom line, businesses must still focus on growing sales, cost control, and other factors.

    Working Capital Management Pros & Cons

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    • Helps track & improve your company’s efficient use of operational capital.
    • Provides insight into areas where you can reduce costs or improve processes.
    • Helps ensure you have enough liquid capital to cover expenses.
    • Assists in balancing short-term and long-term debt.
    • Tracking tools can improve AR & AP management.


    • Only one way to view your company’s financial performance.
    • Cannot increase profitability or market share.
    • Cannot predict future financial performance or market conditions.

    Frequently Asked Questions

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    Here are the most common questions about working capital management.

    How do Working Capital and Cash Flow impact each other?

    Working capital and cash flow are two of the most important concepts in financial analysis. Working capital is reflected on your balance sheet, while cash flow is reflected on cash flow statements.

    Cash flow tracks the cash or cash equivalents transferred in and out of the company. If your working capital expenses increase, you’re using more cash, so your available cash flow decreases. If you minimize expenses or increase revenue, your available cash flow increase.

    What causes Working Capital to change?

    For most businesses, working capital fluctuates constantly. While some payments remain fixed, many change over time. Payroll changes as new employees are hired or existing employees receive raises. Seasonal changes in revenue and expenses alter working capital throughout the year. Paying off or refinancing existing short-term debt or taking on new short-term debt also changes working capital.

    What can my business do to improve Working Capital?

    One of the primary benefits of working capital management is identifying opportunities to increase your business’s efficiency and financial performance. Here are several ways your business could potentially improve its working capital usage.

    Long-Term Debt

    Taking out long-term working capital loans or other forms of long-term debt can increase your business’s current cash assets without increasing its current liabilities. While the debt is still reflected on your company’s balance sheet under total liabilities, it will increase your available working capital.

    Refinancing Short-Term Debt

    Short-term debt is included in your current liabilities because it must be repaid within the year. When you refinance short-term debt into long-term debt, you move it from current liabilities to total liabilities.

    Liquidating Assets

    Selling off a company’s assets converts them into cash, which increases your working capital. Using this strategy requires balancing which assets you can liquidate versus those vital to your company’s function.

    Reducing Expenses

    Businesses should continually analyze their expenses and overhead to identify areas where it’s spending more than is required for business operations. You can also convert some expenses into long-term assets. For example, if you’re currently renting a workspace but intend to use it long-term, you could consider purchasing the property with a commercial real estate loan. Then you move rent payments off your working capital expenses, and the commercial real estate loan is added to your total liabilities, freeing up more working capital.

    Optimize Inventory Management

    Using inventory analysis to optimize your management strategy helps avoid overstocking and needing to write off unsold inventory. In addition, it can also help you avoid losing sales by not having enough inventory in stock.

    Automating Accounts Receivable

    Many companies use automation software to optimize accounts receivables. These systems allow you to quickly track payments coming and what’s due and send timely payment reminders. Utilizing automation can significantly improve your collection ratio.

    What are my options if my business needs funding help for Working Capital?

    Many businesses need financing help for working capital at some point. However, it can be challenging to obtain the necessary funds.

    Traditional lenders like banks and credit unions have stringent qualifications. You’ll usually need two to three years in business, high annual revenue, and a high personal credit score.

    It can also take a long time to close and fund a traditional business loan from a bank. It could take one to weeks to get approved and then an additional few weeks to receive the funds. That timeline doesn’t work for many businesses when faced with an urgent working capital need.

    Fortunately, alternative lenders and lending marketplaces, like UCS, can offer quick approvals and fast funding. Online lending platforms offer convenient online applications with minimal documentation and lower qualifications.

    The rates for working capital loans from alternative lenders may run higher than traditional financing. However, those costs could be worth it if you need urgent funding.

    Working capital loans through UCS’s lender network offer the following features:

    • Max funding amount: $1k – $5 million.
    • Factor rates: Starting at Prime + 2.75%.
    • Term: 3 months – 10 years.
    • Speed: 1 – 10 business days.

    Approved businesses we work with typically meet the following minimums:

    • Credit score: 550+.
    • Time in business: 2 years+.
    • Annual revenue: $180k+.

    However, some working capital funding options, such as merchant cash advances or invoice factoring, only require a few months in business. Other working capital loan options include business term loans, business lines of credit, and SBA loans.

    Working Capital Management – Final Thoughts

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    Businesses implementing an efficient working capital management strategy have more control over their financial health. It’s a vital component of running a small business.

    Breaking down working capital management into its constituent parts helps improve each area. You can use effective management strategies to improve cash flow and liquidity, manage inventory and accounts receivable, balance short-term and long-term debt, and avoid late payments on your accounts payable.

    You also have options for when your business has a working capital shortage. Several small business loans can help you power through a downturn, unexpected costs, or other working capital needs.

    Contact us if you have more questions on managing working capital or want to apply for a small business loan. Our loan executives can help you find the best working capital funding solution for your business needs.

    We will help you grow your small business.

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