Working capital is the cash tied up in running the business day to day: stock waiting to be sold and money owed by customers, less what the business owes its suppliers. The longer stock sits and customers take to pay, and the faster suppliers are paid, the more cash the business needs, and the more it needs as sales grow. Cash is released by shortening the stock and debtor cycle and agreeing sensible supplier terms, not just by borrowing.

What is working capital and why does it drive cash needs?

ACCA defines working capital as current assets less current liabilities, in practice mainly inventory, trade receivables, trade payables and any overdraft. It makes the point that many businesses which appear profitable are forced to stop trading because they cannot meet short term obligations as they fall due, and that failure to control working capital is a major cause of business collapse.

The reason is timing. A business usually pays for materials and wages before it sells, and sells before it is paid. Every pound in stock or in debtors is a pound not in the bank. ACCA describes two objectives in tension: liquidity, so bills can be paid on time, and profitability, because money sitting in working capital earns little or no return. Too little working capital is overtrading; too much is inefficiency.

How do you measure the cash operating cycle?

ACCA calculates the cash operating cycle, also called the working capital or cash conversion cycle, as inventory days plus receivables days less payables days. It is the number of days between paying suppliers and receiving cash from customers.

  • Inventory days = inventory ÷ cost of sales × 365
  • Receivables (debtor) days = trade receivables ÷ credit sales × 365
  • Payables (creditor) days = trade payables ÷ credit purchases (or cost of sales) × 365

ACCA notes that the cycle depends on the nature of the business. A supermarket can have a negative cycle because it collects cash from customers before it pays suppliers, while a construction company may have a very long cycle because of high levels of work in progress. Comparisons should be with the business’s own trend and with similar businesses, not with a universal benchmark. The current ratio and quick ratio, covered in KPIs for small businesses, give a balance sheet view of the same issue.

What does a worked example look like?

Illustration only. A wholesaler has annual sales of £1.2 million, all on credit, and cost of sales of £800,000. It holds 60 days of stock, customers take 50 days to pay, and it pays suppliers in 30 days. Its cash operating cycle is 60 + 50 less 30, which is 80 days.

Element Calculation Cash tied up £
Stock £800,000 × 60 ÷ 365 131,507
Debtors £1,200,000 × 50 ÷ 365 164,384
Less creditors £800,000 × 30 ÷ 365 (65,753)
Net working capital 230,138

Cutting stock by 15 days releases about £32,877, cutting debtor days by 10 releases another £32,877, and agreeing 10 more days with suppliers adds about £21,918: around £87,700 in total without any change in profit. The same arithmetic works in reverse when the business grows. If sales rise by 25% and the day counts stay the same, working capital rises by about £57,500, which must be funded before the extra profit arrives. This is why fast growing businesses so often run short of cash; build the effect into cash flow forecasts.

How can you release cash from stock?

ACCA’s guidance on inventory control lists the reasons for holding stock (meeting demand, bulk discounts, fewer orders) against the costs (storage, the cost of capital tied up, deterioration, obsolescence and theft). Practical steps for a small business:

  • Rank lines by sales and margin and cut ranges where slow lines tie up cash.
  • Set reorder levels and order quantities per line based on actual usage and supplier lead times, rather than ordering by habit. ACCA’s economic order quantity model balances ordering costs against holding costs.
  • Weigh bulk discounts against the holding cost of the extra stock before accepting them.
  • Clear obsolete and damaged stock. It is worth more as cash now than at full value on the balance sheet, and it may already need writing down to net realisable value; see stock valuation.
  • For project businesses, invoice stages promptly so that work in progress turns into debtors quickly.

How can you release cash from debtors?

Agree terms before work starts, invoice immediately and accurately, and chase systematically from the due date. The day to day process is covered in credit control and the aged debtors report. The law gives business suppliers some leverage. GOV.UK guidance on late commercial payments says:

  • an agreed payment date must usually be within 60 days for business transactions (30 days for public authorities), although a longer period can be agreed if it is fair to both businesses;
  • if no date is agreed, payment is late 30 days after the customer receives the invoice or the goods or services are provided, whichever is later;
  • statutory interest on late business to business payments is 8% plus the Bank of England base rate, unless the contract sets a different rate;
  • a fixed sum for recovery costs can be added once per payment: £40 for debts up to £999.99, £70 for £1,000 to £9,999.99, and £100 for £10,000 or more.

Two financing tools speed up collection. Early settlement discounts can be expensive: ACCA’s example shows that offering 1% for payment in 10 days to customers who currently pay in 41 days costs about 12.6% a year, more than a typical overdraft. Invoice discounting and factoring advance a proportion of outstanding invoices in return for interest and charges; they accelerate cash but do not fix slow paying customers.

How should you manage what you owe suppliers?

Taking longer to pay suppliers releases cash, but ACCA cautions that pushing too hard can lead a supplier to demand cash on delivery, which cuts payables days to zero. Negotiate terms openly, pay on the agreed date rather than early, and keep good suppliers on side. Check whether a prompt payment discount is worth more than the cost of funding the earlier payment.

When selling to large businesses, it helps to know how they pay. GOV.UK’s service for checking when large businesses pay their suppliers publishes reports from companies and LLPs that meet at least two of £54 million turnover, £27 million balance sheet total and 250 employees; these businesses must report at least twice a year, including average payment time and the proportion of invoices paid late. That information can be used when agreeing terms or forecasting receipts.

What about VAT, PAYE and other tax payments?

Tax is a working capital item too. VAT collected on sales is held until the return is due, which can mask a cash problem until the payment date. A business whose customers pay slowly may benefit from the VAT Cash Accounting Scheme, which accounts for output VAT when customers pay; GOV.UK says it is available where estimated VAT taxable turnover is £1.35 million or less in the next 12 months, and a business must leave when turnover exceeds £1.6 million. Where a tax bill cannot be met, HMRC may agree a Time to Pay arrangement, which is better approached early than after a payment is missed.

What is overtrading and how do you spot it?

ACCA describes overtrading as having insufficient working capital to support the level of business activity, characterised by a high and rising proportion of short term finance to long term finance. Warning signs include rapid sales growth, a rising overdraft despite reported profits, lengthening creditor days because suppliers are being paid late, falling current and quick ratios, and stock or debtors growing faster than sales. The answer is usually some combination of tighter collection, slower growth, and long term funding such as equity or a term loan matched to the permanent increase in working capital, rather than an ever larger overdraft.

Common mistakes include judging performance on profit alone, offering long credit terms to win work without pricing in the cost (see pricing methods), treating supplier credit as free, and failing to model the working capital needed before taking on a large contract.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.