A business can be profitable, have strong sales, and still struggle to grow.

One reason is that growth often requires cash before the additional revenue reaches the business bank account.

You may need to purchase inventory, pay employees, cover supplier invoices, or invest in additional resources before customers pay you.

This is where working capital becomes important.

Working capital helps a business fund its day-to-day operations and manage the timing difference between money going out and money coming in.

Understanding your working capital position can help you determine whether your business is financially prepared for growth or whether expansion could create unnecessary cash-flow pressure.

What Is Working Capital?

Working capital is a measure of the short-term financial resources available to a business.

A commonly used formula is:

Working Capital = Current Assets − Current Liabilities

Current assets generally include assets expected to be converted into cash or used within the short term, such as:

• Cash
• Accounts receivable
• Inventory
• Other short-term assets

Current liabilities can include obligations that need to be paid in the short term, such as:

• Supplier invoices
• Short-term debt
• Accrued expenses
• Other current business liabilities

For example, if a business has:

Current assets: $300,000

Current liabilities: $200,000

Its working capital is:

$300,000 − $200,000 = $100,000

However, the amount of working capital alone doesn’t tell the entire story.

The composition and timing of those assets and liabilities also matter.

Why Is Working Capital Important?

Working capital helps support the everyday operation of a business.

It can be used to fund:

• Payroll
• Supplier payments
• Inventory
• Rent
• Utilities
• Operating expenses
• Short-term commitments

Without sufficient working capital, a business may struggle to pay its obligations even if it is profitable.

This is especially important during periods of rapid growth.

Working Capital and Cash Flow Are Closely Connected

Working capital and cash flow are related, but they are not the same thing.

Cash flow focuses on the movement of money into and out of the business.

Working capital looks at the relationship between short-term assets and short-term liabilities.

For example, imagine your business makes a large number of sales on credit.

Your accounts receivable may increase significantly, which can increase current assets.

However, if customers don’t pay for another 60 days, that money isn’t immediately available to pay your suppliers or employees.

This is why having strong working capital on paper doesn’t always mean having plenty of cash available today.

How Does Working Capital Affect Business Growth?

Growth often requires additional working capital.

This may seem surprising.

You might assume that more sales automatically mean more money.

But consider what happens when sales increase.

You may need to:

• Buy more stock
• Hire additional employees
• Pay suppliers earlier
• Increase production
• Take on more projects
• Offer customers credit
• Increase marketing expenditure

The additional revenue may not be collected immediately.

This creates a funding gap.

The faster your business grows, the more important it becomes to understand that gap.

A Simple Example of Growth Creating Cash Pressure

Imagine a business currently generates $100,000 in monthly sales.

Customers typically pay within 30 days.

The business spends $60,000 per month on inventory, wages, and other operating costs.

Now imagine sales increase to $150,000 per month.

That sounds like excellent news.

However, the business may need to purchase significantly more inventory and increase staffing before it receives the additional customer payments.

The business may therefore need additional working capital to fund the growth.

This is sometimes called growth-consuming cash.

What Are the Main Components of Working Capital?

Three areas deserve particular attention.

Accounts Receivable

Accounts receivable represents money customers owe the business.

If customers take longer to pay, more cash becomes tied up in receivables.

Monitor:

• Total outstanding invoices
• Average payment time
• Overdue invoices
• Customer payment patterns
• Credit terms

Improving collections can release cash back into the business.

Inventory

Inventory represents money that has been spent but hasn’t yet been converted into sales.

Too much inventory can tie up cash.

Too little inventory can create stock shortages and missed sales.

The objective is to maintain an appropriate level based on the business’s sales patterns and supply requirements.

Accounts Payable

Accounts payable represents money the business owes suppliers and other creditors.

Supplier payment terms can affect how much working capital the business needs.

For example, if suppliers require payment within seven days but customers take 45 days to pay, the business may need significant working capital to bridge the gap.

What Is the Working Capital Cycle?

The working capital cycle looks at the time it takes for money invested in the business to return as cash.

For a product-based business, the process might look like:

Purchase inventory → Sell inventory → Invoice customer → Customer pays → Cash returns to business

The longer this cycle takes, the more working capital the business may need.

Reducing the time between spending money and receiving customer payments can improve cash flow.

How Can You Improve Working Capital?

There are several ways a business can improve its working capital position.

Collect Customer Payments Faster

Review your payment terms and collection process.

You may be able to improve cash flow by:

• Issuing invoices promptly
• Offering convenient payment methods
• Following up overdue invoices
• Setting clear payment terms
• Requesting deposits where appropriate
• Reviewing credit arrangements

Small improvements in payment timing can have a significant impact as a business grows.

Manage Inventory Carefully

Avoid holding more inventory than the business needs.

Review:

• Slow-moving stock
• Overstocked products
• Stock turnover
• Purchasing patterns
• Minimum stock levels

Money sitting in unsold inventory isn’t available for other business needs.

Review Supplier Terms

Where appropriate, negotiate supplier terms that better align with your customer payment cycle.

For example, longer supplier payment terms may reduce the amount of working capital required.

However, supplier relationships and agreed payment terms should always be managed responsibly.

Improve Pricing

Pricing affects how much cash the business generates from each sale.

If your margins are too low, increasing sales may require significantly more working capital without producing enough additional profit.

Review whether your prices adequately reflect:

• Materials
• Labour
• Overheads
• Financing costs
• Delivery
• Business risk
• Desired profit

Growth Can Increase Working Capital Requirements

One of the most important things business owners should understand is that working capital requirements can increase as revenue increases.

Suppose a business grows from $1 million to $2 million in annual revenue.

It may need:

• More stock
• More staff
• More equipment
• More receivables funding
• More supplier payments

The business therefore needs to plan not just for the additional revenue, but for the additional resources required to generate that revenue.

Is More Working Capital Always Better?

Not necessarily.

Having sufficient working capital is important, but excessively large amounts of money tied up in inventory or receivables can reduce efficiency.

For example, a business might have strong current assets because it is carrying significant amounts of slow-moving inventory.

That doesn’t necessarily indicate strong financial performance.

The goal is to maintain appropriate working capital, not simply maximise the number.

What Is a Healthy Working Capital Ratio?

A commonly used measure is the current ratio:

Current Ratio = Current Assets ÷ Current Liabilities

For example:

Current assets = $300,000
Current liabilities = $200,000

Current ratio:

$300,000 ÷ $200,000 = 1.5

This means the business has $1.50 of current assets for every $1 of current liabilities.

However, there is no single current ratio that is automatically “healthy” for every business.

The appropriate level depends on:

• Industry
• Business model
• Cash-flow patterns
• Inventory requirements
• Customer payment terms
• Supplier terms
• Debt
• Business size

A ratio should therefore be considered alongside the wider financial picture.

Working Capital for Service Businesses

Working capital isn’t only relevant to businesses that sell physical products.

Service businesses can also experience working capital pressure.

For example, a consulting or professional services firm may incur:

• Employee wages
• Contractor costs
• Software expenses
• Rent
• Marketing costs

before customers pay their invoices.

The business may therefore need sufficient cash reserves to fund its operations while waiting for customer payments.

Working Capital and Hiring Employees

Hiring can increase working capital requirements.

The employee needs to be paid regularly, while the additional revenue they generate may arrive later.

Before hiring, consider:

• Salary
• Superannuation
• Payroll-related costs
• Equipment
• Software
• Recruitment costs
• Training
• Expected revenue contribution

A cash-flow forecast can help determine whether the business can comfortably fund the additional costs.

Working Capital and Large Projects

Project-based businesses can face particularly significant working capital requirements.

For example, a business may need to purchase materials and pay subcontractors before receiving progress payments from a customer.

If several projects are running simultaneously, the working capital requirement can increase substantially.

This is why project timing, payment terms, and job costing should be considered when planning growth.

Signs Your Business May Have a Working Capital Problem

Watch for warning signs such as:

• Regularly struggling to pay suppliers
• Increasing reliance on overdrafts or short-term finance
• Customers consistently paying late
• Large amounts of cash tied up in inventory
• Strong sales but limited cash
• Difficulty funding new projects
• Delayed payments to suppliers
• Increasing short-term debt

These signs don’t necessarily mean the business is in financial trouble, but they may indicate that working capital needs closer attention.

How Can You Plan Working Capital for Growth?

Before pursuing significant growth, consider preparing a cash-flow forecast.

Model:

• Expected sales
• Customer payment timing
• Inventory requirements
• Staffing costs
• Supplier payments
• Tax obligations
• Capital expenditure
• Existing debt

Then ask:

How much additional cash will the business need to support the planned growth?

This can help you identify a funding requirement before it becomes urgent.

Working Capital Isn’t Just a Finance Issue

Working capital can influence many operational decisions.

It can affect:

• Pricing
• Customer payment terms
• Supplier negotiations
• Inventory management
• Hiring
• Project selection
• Growth strategy
• Financing decisions

This means working capital should be considered as part of the broader business strategy rather than treated as an accounting number that only matters at reporting time.

How Can an Accountant Help With Working Capital?

Understanding working capital can become more complex as a business grows.

An accountant or business adviser can help you analyse:

• Accounts receivable
• Accounts payable
• Inventory
• Cash flow
• Current liabilities
• Working capital ratios
• Growth requirements
• Funding needs

At Latitude Accountants, we help Australian business owners understand the financial drivers behind their businesses and plan for sustainable growth.

The objective isn’t simply to increase sales.

It’s to ensure the business has the financial capacity to support those sales profitably and sustainably.

Frequently Asked Questions About Working Capital and Business Growth

What is working capital in simple terms?

Working capital is the difference between a business’s current assets and current liabilities. It helps indicate whether the business has sufficient short-term resources to support its operations.

Why does working capital matter for business growth?

Growth can require additional cash to fund inventory, employees, suppliers, and other expenses before customers pay. Without sufficient working capital, rapid growth can create cash-flow pressure.

What is the formula for working capital?

The basic formula is Current Assets − Current Liabilities = Working Capital.

Is working capital the same as cash?

No. Cash is one component of current assets. Working capital can also include accounts receivable, inventory, and other short-term assets, less current liabilities.

Can a profitable business have a working capital problem?

Yes. A business can be profitable while having cash tied up in unpaid invoices, inventory or other assets, creating difficulty meeting short-term obligations.

How can a business improve working capital?

Businesses can potentially improve working capital by collecting customer payments faster, managing inventory efficiently, reviewing supplier terms, improving pricing and carefully managing expenses.

Does business growth always require more working capital?

Not always, but many growing businesses require additional working capital because higher sales can increase inventory, receivables, staffing and other operating requirements.

Talk to Latitude Accountants About Working Capital and Business Growth

Growing your business is exciting, but growth also creates financial demands.

Understanding your working capital position can help you determine whether your business is financially prepared to support additional sales, employees, projects and investment.

Latitude Accountants provides accounting, budgeting, forecasting, tax planning and business advisory services to help Australian business owners understand their numbers and plan for sustainable growth.

If you’re planning to grow your business and want to understand how that growth could affect your cash flow and working capital, our team can help you assess the numbers.

Latitude Accountants

📍 Sydney Olympic Park | Marrickville | Melbourne | Loxton
📞 1300 706 597
📧 info@latitudeaccountants.com.au

Want tailored business advice? Let’s chat.

Disclaimer

This article provides general information only and does not constitute financial, tax, accounting or business advice. Working capital requirements and appropriate financial ratios vary depending on the industry, business structure, operating model and individual circumstances. You should seek advice from an appropriately qualified professional before making financial or business decisions based on the information provided.