Quick Answer
Working capital is the difference between current assets (cash, receivables, inventory) and current liabilities (payables, accruals, short-term debt). It measures a company ability to meet short-term obligations and fund day-to-day operations. Positive working capital means you can pay your bills; negative working capital (common in SaaS with annual prepayment) means you collect cash before delivering the service. Efficient working capital management optimises the cash conversion cycle.
Working capital = Current assets - Current liabilities
Current assets include: cash and bank balances, trade receivables (debtors), inventory (stock), prepayments, and other amounts receivable within 12 months.
Current liabilities include: trade payables (creditors), accrued expenses, deferred revenue, VAT and tax liabilities due within 12 months, and short-term borrowings.
The cash conversion cycle (CCC) measures how many days it takes to convert your investment in inventory and receivables into cash:
CCC = Debtor days + Stock days - Creditor days
Debtor days: How long customers take to pay you. UK average for SMEs is approximately 55 days.
Stock days: How long inventory sits before being sold (relevant for product businesses).
Creditor days: How long you take to pay suppliers.
A shorter cash conversion cycle means cash circulates faster, reducing the amount of working capital the business needs.
Product businesses. Significant working capital tied up in inventory and receivables. Managing stock levels and debtor collection is critical.
Service businesses. Less inventory but potentially large receivables. Managing billing terms and collection processes is key.
SaaS businesses. Often have negative working capital — customers pay upfront (annual subscriptions) before the service is delivered, creating deferred revenue (a current liability). This is a favourable position for cash flow.
Reduce debtor days: - Invoice promptly — on delivery or contract signature, not at month-end - Offer early payment discounts (e.g., 2% discount for payment within 10 days) - Follow up overdue invoices proactively - Consider invoice factoring for large, slow-paying customers
Extend creditor days (carefully): - Negotiate longer payment terms with suppliers - Use the full payment term — do not pay early unless there is a discount incentive - Be careful not to damage supplier relationships or credit terms
Optimise inventory (product businesses): - Implement demand forecasting to reduce overstock - Identify and clear slow-moving stock - Negotiate consignment or just-in-time arrangements with suppliers
FP&A should model working capital as part of the cash flow forecast, using assumptions about debtor days, creditor days, and stock days. Sensitivity analysis on these assumptions shows the cash impact of improving or deteriorating working capital efficiency.
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FAQ
Not necessarily. For SaaS companies with annual prepaid subscriptions, negative working capital reflects customers paying before service delivery — this is a strong cash position. For other businesses, negative working capital may indicate an inability to meet short-term obligations. Context matters.
Express working capital drivers as ratios: debtor days (trade receivables / revenue x 365), creditor days (trade payables / cost of sales x 365), and stock days (inventory / cost of sales x 365). Apply these ratios to your P&L forecast to project balance sheet movements and cash flow impact.
This UK legislation gives businesses the right to charge interest (8% above Bank of England base rate) and claim compensation on late commercial payments. While rarely enforced, it is a useful tool for managing late-paying customers and can be referenced in payment reminder communications.
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