Working capital is one of the most difficult financial concepts for the small-business owner to understand. In fact, the term means a lot of different things to a lot of different people. By definition, working capital is the amount by which current assets exceed current liabilities.

As an accounting measure, it does not provide much insight into the daily management of your business’s working capital requirements and how to meet them.

A more useful tool for determining your working capital needs is the operating cycle.

The operating cycle refers to the debtor, inventory and creditor cycles in terms of days. In other words:

  • Debtor days are the average number of days it takes to collect an account.
  • Inventory days are the average number of days it takes to turn over the sale of a product (from the point it is delivered as stock to the point it is converted to a cash or a credit sale).
  • Creditor days are the average number of days it takes to pay a supplier invoice.

The formulas to calculate these are widely available on the internet.

Most businesses cannot finance the operating cycle (debtor days + inventory days) with the working capital available. Consequently, working capital financing is needed. This shortfall is typically covered by the net profits generated internally or by externally borrowed funds or by a combination of the two.

Most businesses need working capital finance at one point or another.

For instance, manufacturers must find working capital to fund out of the ordinary large order inventory requirements to complete the sale. Seasonal businesses also experience this shortfall in internally generated working capital during peak times of the year.

The operating cycle analysis provides one other important insight, in that it becomes clear that working capital management has a direct impact on cash flow in a business.

Since cash flow is the life blood of any business, big or small, a good understanding of working capital management is imperative to making any business successful.

When your business experiences a need for short-term working capital there are several potential sources of funding available. The important thing is to plan ahead.

Without advance planning, you might miss out on the one big order that could put your business in the big leagues.

The five most common sources of short-term working capital financing are:

  1. Equity. If your business is in its first year of operation and has not yet become profitable, then you might have to rely on equity funds for short-term working capital needs. These funds might be injected from your own personal resources or from a family member or a friend.
  2. Trade creditors. If you have a particularly good relationship established with your trade creditors, you might be able to convince them in providing you longer payment terms. By paying your creditors on time, a good relationship will develop and they might be willing to extend your payment terms when you really need it.

For instance, if you receive a big order that you can fulfil, deliver to your client and collect in 60 days, you could obtain 60 day terms from your supplier if 30 day terms are normally given.

  1. Factoring. Factoring is another resource for short-term working capital financing. Once you have filled an order, offering your invoices to Flex Capital to buy, will allow you to collect as much as 80% of the invoice on delivery to your client. By using these funds strategically as part of your working capital management plan, you will give your business a significant advantage. The value to your business that is unlocked this way is usually much higher than the cost of the transaction.
  2. Bank overdraft. Traditionally most businesses used bank supplied overdrafts as short term financing. However, in today’s economic climate, overdrafts are not often given by banks to new businesses. Only if your new business is well-capitalized by equity or if you have good security to offer the bank, will your business qualify for one. The cost of an overdraft is often under calculated as most people only ask what the actual interest rate charged by the bank will be but most often the opportunity cost of the equity/assets that are tied up by the bank’s cession goes unnoticed.
  3. Short-term loan. While your new business may not qualify for an overdraft from a bank, you might have success in obtaining a short-term loan (less than a year) to finance your temporary working capital needs by alternative lending institutions. These loans can be securitized or unsecuritized, depending on various factors. Make use of lending platforms like to connect to one of these funding providers.