Working capital is your current assets (cash, money customers owe you and stock) minus your current liabilities (bills due within a year). The cash conversion cycle, stock days plus debtor days minus creditor days, tells you how long your cash is tied up before it comes back. Shorten that cycle and you free up cash without borrowing.
Profit and cash aren't the same thing. A business can make a healthy profit on paper and still struggle to pay wages, because the money from those sales is sitting in a warehouse or in a customer's bank account. Working capital is the measure that captures that gap.
This guide explains what working capital is, how to work out yours, how to read the cash conversion cycle, and what you can do to improve it before you think about borrowing.
What working capital is
Working capital is the difference between what your business has coming in over the next year and what it has to pay out over the same period:
Working capital = current assets − current liabilities
- Current assets are cash, and things that should turn into cash within a year: money customers owe you (your debtors or trade receivables), stock, and payments you've made in advance.
- Current liabilities are bills due within a year: money you owe suppliers (your creditors or trade payables), VAT, PAYE and corporation tax owed to HMRC, an overdraft, and any loan repayments due in the next 12 months.
Positive working capital means your short-term assets cover your short-term bills. Negative working capital means they don't, which is a warning sign for most businesses. There are exceptions: a business that's paid by customers before it pays its suppliers, as some retailers and restaurants are, can run with negative working capital quite safely.
You'll find the figures on your balance sheet, usually labelled "net current assets". Your latest management accounts give a more up-to-date picture than last year's filed accounts.
How to work out your working capital
Here's a simple example for a wholesaler:
| Current assets | Current liabilities | ||
|---|---|---|---|
| Cash | £20,000 | Suppliers | £45,000 |
| Debtors | £100,000 | VAT and PAYE owed | £25,000 |
| Stock | £67,500 | Overdraft | £30,000 |
| Loan repayments due this year | £12,500 | ||
| Total | £187,500 | Total | £112,500 |
Working capital is £187,500 − £112,500 = £75,000.
The working capital ratio
The working capital ratio, also called the current ratio, compares the two totals:
Working capital ratio = current assets ÷ current liabilities
In the example, that's £187,500 ÷ £112,500 = 1.67. For every £1 due in the next year, the business has £1.67 in current assets.
There's no single right number, and what's normal varies a lot by industry. As a rough guide:
- Below 1 means short-term bills are bigger than short-term assets. Unless your customers pay you before you pay suppliers, it's a sign of strain.
- Well above 1 gives a cushion.
- Very high isn't automatically good. It can mean cash sitting idle, too much stock or customers who are slow to pay.
Lenders often look at the quick ratio too. It's the same calculation with stock left out, because stock can be slow to sell. Here, that's (£187,500 − £67,500) ÷ £112,500 = 1.07. Watching how your ratios move over time tells you more than any single figure.
The cash conversion cycle
The working capital figure is a snapshot. The cash conversion cycle shows you how it moves. It measures how many days pass between paying for stock and getting paid by your customer, and it's built from three numbers:
| Measure | What it tells you | How to work it out |
|---|---|---|
| Stock days | How long stock sits before it's sold | Stock ÷ cost of sales × 365 |
| Debtor days | How long customers take to pay | Trade debtors ÷ credit sales × 365 |
| Creditor days | How long you take to pay suppliers | Trade creditors ÷ purchases × 365 |
Cash conversion cycle = stock days + debtor days − creditor days
Supplier credit shortens the gap, because you're using your supplier's money for a while. Everything else is your money, tied up.
An illustration, not real figures. The wholesaler has sales of £730,000 a year, about £2,000 a day, and cost of sales of £547,500, about £1,500 a day. All its sales are on credit.
- Stock days: £67,500 ÷ £547,500 × 365 = 45 days
- Debtor days: £100,000 ÷ £730,000 × 365 = 50 days
- Creditor days: £45,000 ÷ £547,500 × 365 = 30 days (using cost of sales in place of purchases, a common shortcut)
The cycle is 45 + 50 − 30 = 65 days. For more than two months, the business has paid out cash it hasn't yet got back.
Now say it gets customers paying in 35 days instead of 50. Each day cut from debtor days frees up about a day's sales, so 15 days × £2,000 = roughly £30,000 comes back into the bank, without borrowing a penny.
The figures are approximations. If you're VAT-registered, for example, your debtors include VAT while your sales figure usually doesn't, which nudges debtor days up. Use the same method each time and watch the trend.
Why profitable businesses run out of cash
Running out of cash while making a profit is common, and it usually comes down to timing:
- Growth eats cash. More sales mean more stock and more money owed by customers, all paid for before the sales turn into cash. In the example, 20% more sales would tie up roughly another £24,500 in stock and debtors, net of supplier credit. Growing faster than your cash can support is called overtrading, and it can sink a business with a full order book.
- Slow payers. One big customer stretching from 30 to 90 days can leave a hole that profit doesn't fill. You have legal rights when customers pay late; see our guide to late payment rights.
- Payments that don't show in profit. Loan capital repayments, buying equipment outright and paying yourself dividends all take cash without reducing profit in the same way.
- Tax timing. VAT and corporation tax arrive in lumps, sometimes months after the profit was made, and a good year means a bigger bill.
- Seasonality. Buying stock months ahead of your busy season ties up cash for a long time.
How to improve your working capital
Start with the cycle. Every day you take out of it frees up cash.
Get paid faster (debtor days):
- Invoice promptly and accurately. Send invoices the day the work is done, with the purchase order number and everything the customer needs to approve them.
- Agree clear terms up front and put them in writing. Ask for deposits or stage payments on larger jobs.
- Make paying easy, with bank details on every invoice, and card or direct debit options where they suit your customers.
- Run credit control. Check new customers' credit before you give them terms, send reminders before the due date, and chase on a set timetable.
Hold less stock (stock days):
- Find slow movers and stop reordering them. Clearing old stock at a discount can be better than letting it tie up cash.
- Order little and often where suppliers allow it, even if the unit price is slightly higher. Weigh the saving against the cash tied up.
Use supplier terms well (creditor days):
- Negotiate longer terms, particularly as you become a bigger, reliable customer.
- Pay on the agreed date, not early, unless there's a worthwhile early-payment discount.
- Don't stretch suppliers without agreement. It damages relationships, can cost you credit and invites late payment claims.
When funding fits
Sometimes the cycle is as tight as it reasonably gets, and the business still needs more working capital, especially when it's growing. That's when funding makes sense, and the right type depends on where your cash is stuck:
| Where the cash is tied up | Funding that fits | Why |
|---|---|---|
| Short, unpredictable swings | Overdraft or revolving credit facility | Borrow only what you need, when you need it |
| Unpaid invoices to business customers | Invoice finance | Releases most of an invoice's value within days, and grows with your sales |
| Stock or seasonal build-up | Stock or trade finance | Funds the purchase and is repaid as the stock sells |
| A lasting increase from growth | A term loan, alongside a facility | Funds the permanently higher level of stock and debtors |
Our guides compare these in detail: overdrafts, revolving credit and loans, invoice finance vs a business loan, and stock and seasonal finance.
The principle is to match the funding to the cash gap. A facility that rises and falls with your cycle usually fits working capital better than a fixed loan. Borrowing to plug a gap you could close by collecting debts faster just adds cost.
Common mistakes to avoid
- Watching profit and not cash. Check your bank forecast as often as your sales.
- Growing without a cash plan. Before taking a big new contract, work out how much cash it will tie up and for how long.
- Giving long terms by default. Payment terms are a negotiation, not a formality.
- Letting stock pile up. Every pallet sitting still is cash you can't use.
- Using a long-term loan for a short-term gap, or the reverse. Match the term of the funding to the need.
- Forgetting HMRC. VAT and PAYE are current liabilities. Money you're holding for HMRC isn't yours to spend.
Questions people ask
What is working capital in simple terms?
Working capital is the money a business has available to run day to day. It's calculated as current assets, such as cash, money owed by customers and stock, minus current liabilities, the bills due within a year. Positive working capital means your short-term assets cover your short-term bills.
What is a good working capital ratio?
There's no single right figure, and it varies by industry. Below 1 means short-term bills exceed short-term assets, which is usually a sign of strain. A very high ratio can mean cash, stock or unpaid invoices are tied up when they could be put to better use. The trend over time matters more than one figure.
How do you calculate the cash conversion cycle?
Add your stock days to your debtor days, then subtract your creditor days. The result is the number of days your cash is tied up between paying for stock and being paid by customers. A shorter cycle means less cash is tied up.
Why does my business have no cash when it's making a profit?
Usually because the profit is tied up in stock and unpaid invoices, or has gone on things that don't reduce profit, such as loan repayments, equipment or tax bills. Growth makes it worse, because more sales tie up more cash before they're paid for.
What is the best finance for working capital?
It depends on where your cash is tied up. An overdraft or revolving credit facility suits short swings, invoice finance suits businesses waiting on customer payments, and stock finance suits stock-heavy or seasonal businesses. A term loan can fund a lasting increase from growth.
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This guide is general information, not financial advice. Rates, rules and lender criteria change, so check the details with your broker or lender before you sign anything. Lending Lenny is not a lender.