Working Capital
Working capital is current assets minus current liabilities: receivables and inventory add to it, while payables reduce it.
By Nick Bryant, Co-Founder and CTO, SMB Investor Network
2 min read
Why working capital matters to people buying a small business
A business can show earnings and still lack what it needs to serve the next customer. If products are out of stock or customer payments haven't arrived, the new owner has an operating problem despite the sales history.
Paying for earnings assumes the business has the resources to keep producing them. Receivables and inventory tie up cash, while payables can delay cash outflows. The buyer's question is what the business needs to keep doing the work behind its reported earnings.
That holds whether you run the company yourself or add it to an existing business. Shared ownership doesn't make slow customer payments or missing stock go away. Read the working capital due diligence guide for the broader operating context.
How working capital is used
Working capital ties together sales, customer payments, and the resources used to fill orders. A receivable is money a customer owes. Inventory is products or materials held for use or sale. What they are worth depends on what happens in the business, not the balance on the books.
Picture a parts distributor that holds stock to fill orders as they come in. Customers get their parts before paying. While the distributor waits for payment, it still needs stock for the next orders.
If the shelves run low, customers don't get the service they expect. If customers pay late, cash from completed sales stays out of reach. That is why inventory and receivables belong in the same conversation. How much working capital a particular business needs is a separate, business-specific question.
Common mistakes with working capital
Treating reported earnings as spendable cash hides the resources those earnings depend on. The business still has to fill orders and wait to be paid.
Another mistake is treating every receivable or item of stock as equally useful. Money owed has to be collected, and inventory has to match what customers want. A balance alone doesn't show either. Compare receivables with subsequent collections, and inventory with recent sales and aging records.
Buyers also drop the question once the financial review is done. Stock levels and customer payments still matter after the ownership change.
Related terms
Accounts receivable covers the amounts customers owe and why invoices need a collection history. A transition plan connects open operating questions with responsibility during the handoff.