Working Capital and Cash Flow: Understanding Both Metrics to Meet Business Financial Expectations

As a new small business owner, there are numerous tasks that now have to deal with on a daily basis. You have to make sure employees deliver the right services and products to customers. You also need accurate accounting services to manage business revenue, payroll, and expenses. So when people start throwing out new terms such as “working capital” and “cash flow,” you can start to become confused.

What is Working Capital and Cash Flow?

These two terms are not the same. Yet they do work together when it comes to letting you know about the current and future success or failure of your business.

Cash flow represents all the money that is flowing into and out from your business during a specified time frame. Cash flow can consist of accounts receivable, accounts payable, and inventory. So your sales transactions with customers, collection processes, invoices you have to pay to suppliers, office rent, loan payments and merchandise are considered cash flow.

Working capital refers to all the current assets as well as current liabilities in your small business. A current asset isn’t just the cash that you keep in your cash register. It also represents any assets such as equipment or inventory that can be converted into cash, which is called operating liquidity. Current liabilities are all expenses and debts that become due within a 12-month period.

What Can These Key Financial Metrics Tell You?

Both working capital and cash flow can give key indications regarding the financial health of your business now as well as in the future. By understanding both of these metrics, you can have a snapshot of how effectively your company is bringing in money and investing it back into your business operations.

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When you have positive working capital, this phrase means that your small business is bringing in cash flow and current assets that can cover all business liabilities. If you have negative working capital, it means that your business cannot cover the current liabilities as you have more cash flow moving out of your business than what you are moving into it.

Now, just because your business has fantastic cash flow moving into your operations doesn’t mean that you have positive working capital. Your business may have incurred large, ongoing debts or you have invested significant amounts of money into the facilities where one slow sales season could see your business in financial trouble.

Managing Working Capital and Cash Flow

The best way to manage working capital and cash flow is to have accurate financial records throughout the life of your company so you can make the right financial decisions. You need to get back to your accounting basics and optimize your accounts receivable/accounts payable tasks so that you are invoicing your customers correctly and in a timely manner to further generate cash flow.

You also need to make smarter inventory management decisions. You want your small business to have the right amount of inventory to satisfy sales orders without sinking too much money into buying products that won’t move off the shelves fast enough.

Another thing to consider is how you are investing in your company. Are you purchasing equipment and products that are essential to operations and business growth or just throwing money away on the newest innovations that won’t have a significant impact on processes? Also, consider whether it is the right time to acquire debt from bank loans for business expansion, or if you are acquiring too much long-term debt that can make it difficult for your business to eventually repay.

Having accurate bookkeeping and financial records will always allow you to keep track of your working capital and cash flow for your small business. If you are worried about the financial health of your business, hiring outside accounting services can help you audit your financial records, spot mistakes, and offer advice on how to get your business back on track when you want to improve your working capital and cash flow management.

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