What Every Business Owner Should Know About Working Capital

There are plenty of boring financial terms, weighed down by equally dull formulas, that make active entrepreneurs want to close their eyes and think about the sea, a beach, and palm trees.

But there are also concepts that, if you understand and use them correctly, can actually help you spend more time on that beach.

Working capital, of course, has nothing to do with Karl Marx's theories. In simple terms, it is the amount of money a business needs to keep its production or service process running without interruption. For a manufacturing company, it is the money circulating in the business between buying raw materials, producing goods, selling them, and collecting payments. It does not include capital investments such as buying equipment or expanding production capacity.

The Three Core Components of Working Capital

To understand and calculate working capital, you need to know three key elements:

• Inventory – the value of raw materials and finished goods sitting in your warehouse

• Receivables – money your customers owe you

• Payables – money you owe your suppliers

How the Calculation Works

Imagine you've invested money to produce a batch of goods. You've already sold part of it, but the customers haven't paid yet. You add up the value of the remaining inventory and the amount customers still owe you. That total is money still tied up in the business – you cannot simply take it out for personal use or other purposes.

Now imagine some of the raw materials and components you used were purchased on credit and you haven't paid your suppliers in full yet. That means part of the funding for your operating cycle is effectively coming from them. To see how much of your own money is really locked into the cycle, you adjust the previous total by subtracting the amount you owe suppliers.

So, in a simplified view, working capital can be calculated as:

Working capital = Inventory + Receivables − Payables

The Cash Buffer – The Lifeblood of Day-to-Day Operations

For a first approximation, these three components are enough. In more detailed calculations, you would also include items such as unpaid wages, short-term loans used to finance operations, accrued taxes, and other elements. All of them form part of the money that ends up "tied up" in the operating cycle.

There is one element that deserves special attention: cash on hand.

For the wheels of your business to keep turning and operations to run smoothly, you need a minimum cash cushion on your bank account. If at some point you don't have enough cash to pay salaries because customers "forgot" to settle their invoices, the entire process is at risk. You won't be able to pay suppliers, they will stop shipping materials, and production will grind to a halt.

This cash buffer is an essential part of healthy financial management and a critical piece of your working capital.

Different Businesses, Different Needs

To keep day-to-day activity going (purchasing, production, sales, and payments), a business needs a certain level of working capital constantly tied up in the cycle. The required amount will vary widely depending on the company's industry and business model.

Some of the biggest factors include:

• Payment terms you grant to customers

• Payment terms you negotiate with suppliers

• How accurately you manage inventory levels

• How quickly your products turn over

A retail store that sells goods daily usually needs far less working capital than a manufacturer that spends three months producing before receiving payment.

Can Working Capital Be Negative? Yes – And That Can Be a Huge Advantage

And it's not just "OK" – in many cases, it's a major competitive advantage.

Imagine this scenario: customers pay you upfront, and you use that money to buy raw materials and pay your team. At the same time, you've negotiated payment terms with your suppliers of 30, 60, or even 90 days.

What happens as a result? At the start of your cycle, you don't need your own money at all. You use customer advances to cover your operating expenses. Even better, in the gap between receiving payments from customers and paying your suppliers, you hold free capital that you can use to grow the business.

If you can sustain that arrangement consistently, you have a truly powerful business model. It allows you to expand naturally, without relying on loans or new investors just to fund working capital.

Who Works This Way?

Retail chains (supermarkets, fashion retailers) and telecom operators are classic examples. Their customers pay at the point of sale or in advance for services, while supplier payments are typically due in 30–90 days. This structural advantage, built into the business model itself, lets them grow without being dependent on debt.

Companies like Apple have turned working capital management into an art. They collect cash from customers almost instantly—think App Store purchases or pre-orders—but pay suppliers 60–90 days later. The result is an enormous internal cash reserve they can use strategically for R&D, acquisitions, or other investments.

The Other Side: When Growth Becomes a Headwind

On the opposite end are businesses whose growth consumes more working capital. They face real challenges.

As revenue expands, working capital requirements usually rise in parallel, often at an even faster rate. Double your sales, and you may well need to double inventory and provide more credit to customers, locking more money into the operating cycle.

This creates three major issues:

1. Frozen profits. Earnings aren't immediately available as cash — they stay locked in stock and receivables. That limits how much you can reinvest or distribute to owners.

2. Dependence on external financing. Without bank loans or equity injections, such businesses can't grow quickly. But financing is costly: lenders demand interest; investors demand ownership stakes – both eat into long-term profits.

3. Growth limits. Without affordable funding, expansion slows. The company can only grow as fast as its cash flow allows—often much slower than competitors operating with negative working capital.

The Takeaway

Working capital isn't just a dry accounting term. It reflects how efficient and resilient your business model really is. If your model lets you collect cash faster than you pay it out, you hold a huge advantage. You can scale without debt, protect your margins, and keep control.

If, on the other hand, your business always needs large amounts of working capital to operate, that's not a fatal flaw—but it means you must manage inventory and payment terms with precision and be ready for external financing when necessary.

So, if you dream of spending more time on the beach, start by examining your working capital. You might find hidden cash that's just waiting to join you there!