Introduction to Working Capital Management

For the first section on this site, we would like to present a broad overview of what working capital is and why it's important. In short, working capital is the money a business has available to sustain its operations. It's the capital available to purchase inventory, pay employees, keep the lights on, and finance other short term expenditures. This makes managing working capital a critical business skill. If there is no working capital, there is no business.

Thousands of companies fail each year due to poor working capital management practices. Entrepreneurs often don't account for short term disruptions to cash flow and are forced to close their operations. Many of these companies have viable business models, and would have otherwise succeeded had they better managed their working capital.

Working Capital and Short Term Cash Flows

We will learn the details of what working capital is in later sections, but for now it's helpful to think of working capital as short term capital. A business's cash inflows and cash outflows can be broken into short term and long term categories. For example, sales and accounts receivable are short term cash inflows. Accounts payable and payroll are examples of short term cash outflows. These are cash flows that happen in the very near future. An important component of working capital management is to ensure short term inflows exceed short term outflows in a sufficient amount to sustain the day-to-day operations of the business.

Not only does working capital management involve ensuring the business does not fail due to a short term cash problem, but it also helps to ensure a business does not carry too much cash. Cash is a low return asset. Businesses do not want to keep more of it than they need to for the same reasons you do. Cash stuffed under the mattress produces little return and businesses want the highest return possible on their assets.

Therefore, the effective management of working capital involves finding the right balance between having too little cash, accounts receivable, and inventories, and having too much. This is the skill we will master in this material.