Working Capital

Working capital is the cash trapped in the operating cycle of a business --- the gap between paying your costs and collecting from your customers. It is the reason profitable businesses die.

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What is it?

Working capital = Current assets − Current liabilities. In practice, it is the cash needed to keep the business running between the moment you spend money (buying materials, paying staff, delivering services) and the moment customers pay you.¹

This gap is the operational expression of the profit-vs-cash-flow divergence. You deliver a training programme in April. The client pays in June. For two months, your profit exists on paper but the cash does not. You still need to pay rent, salaries, and suppliers during those two months. Working capital bridges the gap.

In plain terms

Working capital is the fuel a business burns while waiting for customers to pay. Even a profitable business stalls without it --- like a car that runs out of petrol while driving toward a petrol station.

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How does it work?

The cash conversion cycle

The cash conversion cycle measures how many days it takes to convert spending back into cash:

Days inventory + Days receivable − Days payable = Cash conversion cycle

A positive cycle means you pay your suppliers before your customers pay you. A negative cycle (rare and powerful --- Amazon achieves this) means customers pay before you pay suppliers. Most businesses have a positive cycle, requiring working capital to bridge it.

Why growth kills cash

The most counterintuitive working capital problem: growth increases the cash gap. Each new contract requires upfront spending (staff time, materials, infrastructure) before the client pays. The faster you grow, the more working capital you need. A company growing 50% per year with 60-day payment terms needs significantly more working capital than the same company growing 10%.

This is the mechanism behind the “growing company that goes bankrupt” pattern. Revenue is rising. Profit is healthy. But cash is being consumed by the widening gap between spending and collection. Without financing or reserves, the company runs out of cash while the income statement celebrates.

For your transition

As a freelancer or small business owner, working capital management is simpler but no less critical. If you deliver a workshop and the organiser pays in 30 days, you need 30 days of expenses in cash. If you run a training programme over 3 months with payment at completion, you need 3 months. Your entrepreneurial-runway must account for this.

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Check your understanding

Five questions (click to expand)

1. Calculate working capital for a business with CHF 50K in current assets and CHF 35K in current liabilities. Is this healthy?
2. Explain why rapid growth can cause a cash crisis even in a profitable business.
3. Connect working capital to entrepreneurial-runway. How does knowing your clients’ payment terms affect your runway calculation?
4. Describe a negative cash conversion cycle and why it gives Amazon a structural advantage.
5. Design a payment structure for a training programme that minimises your working capital need (hint: when do you invoice?).

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Where this concept fits

Where this concept fits

graph TD
    LQ[Liquidity] --> WC[Working Capital]
    PvC[Profit vs Cash Flow] --> WC
    WC --> FS[Financial Statements]
    BE[Break-Even] -.-> WC
    ER[Entrepreneurial Runway] -.-> WC
    style WC fill:#4a9ede,color:#fff

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Sources

Footnotes

1. Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance. Chapter 29 on working capital management and the cash conversion cycle. ↩