Working Capital 101

All companies face the challenge of working capital management.

Working capital is the money (this is the "capital" part of the term) that is required to keep the business operating (this is the "working" part of the term).

In essence it is the difference between money received and money paid. Both have to be operating in nature (i.e. they exclude investor's money, debt, and CAPEX). If a company is able to collect more money than it has to pay every month, it is said to have a positive working capital. If the opposite is true, it is said to have a negative working capital. 

You may be wondering which one is better. The answer is "it depends". Every business -even in the same industry- might have a way of conducting business differently than others. So you could find two very competitive companies in the same industry, where one has a negative working capital and the other has a positive working capital; and both might be thriving.

There are nuances to the metric. It could be a timing issue, it could be that a company is growing its vendor roster and the other isn't. It might mean that the dollars one receives from clients is more spaced than the other. That's why we can have the average working capital, which corrects for seasonality and for the nature of collections vs payments in a specific industry.

As long as the company remains cash flow positive on average (more money in than money going out), the company is doing well. 

As a rule of thumb, it is better for a business to collect earlier and to pay later, as long as these are sustainable.

If you have issues managing your working capital and you need a guideline to improve your cash flow, please feel free to reach out to us at contact@summa.consulting