Working capital explained: the money that runs your business day to day

A plumber finishes a $30k bathroom job in March, buys the fittings in February, pays two apprentices every week, and gets paid in April. For six or seven weeks the business is financing its own customer. That stretch of money, laid out before the customer pays, is working capital in its plainest form.

Most explanations stop at a formula. The formula is useful, but it hides the thing that actually decides whether you are comfortable or stretched: how long your money is out of the bank before it comes back. This guide covers both, with a worked example you can copy using your own figures.

What is working capital, in plain terms?

Working capital is the pool of short-term resources your business has available to keep operating, after allowing for the short-term bills it owes. The standard formula is:

Working capital = current assets − current liabilities

Business.gov.au describes current assets as things you can turn into cash within a year or less, such as cash, inventory and prepaid expenses. Current liabilities are the obligations falling due within a year: accounts payable, credit card balances, accrued wages and the repayment portion of loans due this year.

If current assets are $240k and current liabilities are $180k, working capital is $60k. That is the cushion between what is coming in and what is going out over the next twelve months, as the accounts see it.

Why does the timing matter more than the total?

Because current assets are not all equal. $60k of cash is a different animal from $60k made up of stock on a back shelf and invoices customers haven’t paid.

Think of the working capital cycle as the loop money travels:

1. You pay for stock, materials or labour.
2. You hold stock, do the work or deliver the service.
3. You invoice.
4. The customer pays, and the cash returns to the start of the loop.

The longer the loop, the more money you need parked in it. Two things stretch it: slow-moving stock and slow-paying customers. One thing shortens it: suppliers who give you time to pay. Our glossary entry on the working capital cycle goes through the measure in more detail.

How do I work out how much I need? A worked example

Here is an illustrative wholesaler of garden products. It’s an example only, but the method is the one to use.

Measure	Figure
Average days stock sits before sale	40 days
Average days customers take to pay	35 days
Average days the business takes to pay suppliers	25 days
Average daily operating costs (stock, wages, rent)	$3,200

Cash cycle: 40 + 35 − 25 = 50 days.

Money tied up: 50 days × $3,200 = $160,000.

So this business needs roughly $160k of working capital to keep trading at its current size, whether that comes from its own profits, its owners or finance. If it wins a customer that takes 60 days to pay, the cycle lengthens to 75 days and the requirement jumps to $240k, even though the work is good news.

Try the numbers with the cash flow gap calculator, and compare your two sides of the balance sheet with the working capital ratio calculator.

Why does growth squeeze working capital?

This catches profitable businesses out. Growth means more stock, more wages and more invoices outstanding before the extra revenue arrives. Say the wholesaler above grows 30%. Daily costs rise from $3,200 to about $4,160, and the same 50-day cycle now locks up $208k. The business needs another $48k, and it needs it before the new sales have turned into cash.

Owners often read that as a sign something is wrong, when really it’s arithmetic. Our guide on why profitable businesses run out of cash explains how it happens even with healthy margins.

What does healthy working capital look like?

There is no universal number, and the right level differs by industry. A few patterns are useful:

• Retail and hospitality often pay suppliers on terms and collect from customers immediately, so their ratios can look thin without being a problem.
• Trades, wholesale and manufacturing usually carry more stock and debtors, so they need a wider buffer.
• Service businesses with monthly retainers sit somewhere in between, with wages as the main cash demand.

Lenders tend to read the current ratio (current assets divided by current liabilities) alongside the daily bank balance. A ratio below 1 can raise questions, and one comfortably above it is generally reassuring, but they will also ask what’s inside the assets. Our guide to cash flow ratios every owner should know covers the ratios in order.

How can I free up working capital without borrowing?

Try the free options first. Each one shortens the loop:

• Invoice sooner and chase earlier. A tax invoice raised the day the job finishes starts the clock earlier than one raised at month end.
• Offer a small incentive for prompt payment, or move large customers to shorter terms.
• Negotiate supplier terms from 14 days to 30 where the relationship allows it.
• Clear dead stock with a sale. Cash from slow lines is worth more than a theoretical margin sitting on a shelf.
• Check your GST method. Businesses that qualify can account for GST on a cash basis, which means GST is reported when customers pay rather than when invoices are raised. Ask your accountant whether it suits you.

If you’d like help on supplier terms specifically, see our guide on how to negotiate better supplier terms.

When does finance make sense for working capital?

When the gap is temporary and you can name the date it closes. A large order that will be paid in 45 days, a seasonal stock build, a contract with a slow-paying government client. In those cases a working capital loan, a business line of credit or invoice finance can carry the timing difference, and the repayments come from the cash that the cycle releases.

It makes much less sense when the shortfall is a trading loss that repeats every month. There, the first job is to fix the margin or the costs, because the debt would only postpone the problem.

If you’re weighing your options, cash flow finance and invoice finance are the two most common structures for a timing gap, and each has different costs and security requirements.

Got a gap right now? You can tell us about it in about a minute and we’ll point you to the structure that suits.

Turning a timing gap into a plan

Knowing your cycle in days is a strong position to be in. It lets you say to a lender, or to yourself, “we need $160k to run at this size and $208k if we grow by a third”, rather than “we’re a bit tight”.

If the number is bigger than what you hold, the next step is to see what is available. Putting an enquiry through us takes around a minute. Your credit file isn’t checked at that stage, so asking won’t leave a mark on it. We don’t pass your details around a crowd of lenders; a specialist reads your situation, then phones you to talk through what could fit and what wouldn’t. The more accurate your figures for turnover, debtor days and the size of the gap, the sooner we can get to the right option rather than a near miss.

Talk through your working capital gap →