Working Capital Defined

The working capital cycle illustrates how cash flows into and out of a business

. One cycle is defined by the time between making a product to sell and receiving payment for the product. Often, there are extended periods of time between the different stages of the cycle. The working capital cycle also demonstrates how well a business manages its finances.

The working capital cycle begins when a business purchases the materials needed to manufacture a product. The money to do so may come from the owners personal resources or from outside investors. As a business manufactures a product, production costs, such as payroll, may be incurred. Creditors may also have to paid before the product is finished and can be sold. If it takes a long time for a business to manufacture its products, it needs to ensure that it has enough capital available to fund its liabilities. The last step of the working capital cycle is selling the finished product to customers. Once payment is received for a businesss goods, a new cycle begins. It is possible for several cycles to be in progress at one time.

Many factors can effect the amount of cash available in a working capital cycle. The most common liabilities involved in a cycle are operational expenses and current debts to creditors. However, a business may also have to pay taxes and rent on fixed assets, such as real estate. A business may also increase its cash flow if additional funding through investors or creditors is obtained, assets are liquidated, or dividends from stocks are paid.

Working capital defined refers to the cash a business needs to operate on a day-to-day basis. Working capital also refers to a businesss current assets minus its current liabilities. Current assets include accounts receivables (money owed to the business) and inventory, and current liabilities include accounts payable (money a business owes). Current liabilities are also known as short-term debt, which can be bank loans and lines of credit with other companies. When a businesss liabilities outweigh its assets, the business may be unable to meet necessary operating expenses, such as loans, rent, and inventory purchases.

Businesses that sell goods and services quickly and operate almost entirely on a cash basis have little need for large amounts of working capital. These businesses can easily use the capital raised on a single day to purchase additional inventory and increase sales. However, companies that do not sell goods and services quickly and that maintain many receivables accounts, large amounts of working capital are vital to business operation.

Businesses in need of large sums of working capital can obtain funding from many different sources. Businesses who use large equipment can secure an equipment lease good for three to five years to save money. Leases also help advanced equipment, such as computers, from becoming obsolete. Factoring is also available, and it allows businesses that process credit orders to sell their accounts receivables for immediate funding. Factoring is not considered a loan; therefore, businesses are not burdened with more debt.

by: benjamein Moore

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