Working Capital
Business Arithmetic — the cash engine and the fuel that keeps day-to-day operations running
The Need for Capital
| Aspect | Fixed Assets (longer-term) | Working Capital (day-to-day) |
|---|---|---|
| Purpose | Investing in longer-term assets like land, building, machinery | Funding day-to-day operations — buying raw materials, paying rent, wages, utility bills |
| Cash inflow | Don't directly generate cash inflow from sale | Ensures liquidity to pay debts and expenses as they become due |
| When needed | Long-term commitments | Especially during start-up, before profitability is reached |
The Operating Cycle
The need for working capital arises from the time lag between spending money on inputs and receiving money from sales. This duration is the Operating Cycle or Cash Conversion Cycle (CCC) — the time cash is tied up in operations.
The cash engine — tap a stage
Tap any stage to see what happens there. Follow the arrows — the cycle always ends where it began, back at cash.
Cash cycle in a trading business
Longer cycle → more working capital
Different products and businesses have different operating cycles. Longer cycles require more working capital; shorter cycles require less. A jewellery shop keeps gold for months before a sale — a huge operating cycle and working capital need. A roadside chaat stall turns ingredients into cash within hours.
Gross and Net Working Capital
| Aspect | Current Assets | Current Liabilities |
|---|---|---|
| Definition | Items expected to convert to cash within the operating cycle (or within a year) | Short-term funding sources due within a short period (generally a year) |
| Examples | Stock, Debtors, Cash, Short-term investments | Trade creditors, Short-term loans, Outstanding expenses, Provisions |
Key Takeaways
Key Takeaways
- Working capital funds the normal day-to-day operations — buying raw materials, paying rent, wages and utility bills.
- The operating cycle (cash conversion cycle) is the time cash stays tied up between buying inputs and receiving cash from customers.
- Trading cycle: Cash → Stock → Sales → Debtors → Cash; Manufacturing cycle: Cash → Raw Material → WIP → Finished Goods → Sales → Debtors → Cash.
- Longer operating cycles require more working capital; shorter cycles require less.
- Gross working capital = total current assets (cash, inventory, debtors, short-term investments).
- Net working capital = Current Assets − Current Liabilities.
- So what? — The longer your money sleeps as stock or pending bills, the more fuel your engine needs. Speed the cycle, shrink the need.