Most business owners think of Working Capital as the amount of cash they have in the bank. But virtually all financial analysts, advisors and lenders define it as the difference between Current Assets and Current Liabilities. One sounds simple and easy to understand, the other a bit esoteric. Why do they make it so complicated? The answer: because it really matters.

Cash in the bank is real and always dependable – today. But what about tomorrow? Many business owners don’t get regular forecasts of future cash balances or future cash flows, which often results in a surprise when the customers don’t pay on time or an unexpected expense suddenly arrives at the door. If cash is tight that surprise can be alarming or worse.

So let’s look a little deeper. Current Assets are those things a company owns that are either cash or will become cash in the next 12 months, typically mostly composed of accounts receivable and inventories. Those are the assets that will convert into cash for the purpose of paying the Current Liabilities, those that are due for payment in the next 12 months. A quick look at a company’s balance sheet will usually show that current assets are more than current liabilities – a good thing since that’s where the resources to pay the bills will come from. But wait a minute. What if the assets are only slightly larger than the liabilities? And what if the receivables contain some slow paying customers, pretty common these days, especially if your customers were impacted by COVID? And what if the inventories include some stock that is slow moving – meaning we hope it’s not dead yet? Now those assets are going to turn into cash more slowly, and some of them might not make the turn at all. Oops! It’s not likely you can call your creditors and tell them you’ve got to write down some of your assets so you’ll have to write down some of your liabilities too, to keep things in balance. Wouldn’t that make it easier?

So what’s the takeaway from this little financial management tidbit? Here are a few:

• The spread between current assets and current liabilities, if it’s consistently too narrow, may mean your margins are too thin, and that’s a whole different set of problems.
• Strive to have $2 of current assets for every $1 of current liabilities, just to provide a robust cushion against the issues noted above.
• If you manage your current assets carefully, your current liabilities will almost manage themselves. That means collect your receivables and pay attention to your inventory.

If you manage your Working Capital effectively, tomorrow’s cash will be positive, and that’s a good thing.

We are Your CFO for Rent.