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Managing Cashflow Versus Working Capital in a Growing Business

Updated: May 1

Understanding the Financial Pulse of Your Business: Cashflow Versus Working Capital

As the backbone of Australia's economic landscape, small and medium-sized enterprises (SMEs) often grapple with the complexities of financial management. One area that is essential to have a clear understanding is the difference between cashflow and working capital. Although these terms are sometimes mistakenly used interchangeably, they signify distinctly difference financial indicators, and both hold unique implications for your business's vitality.

At Ascern Advisers, we understand these financial metrics and their critical role in shaping the path of your business. In this article we'll explain the differences between cashflow and working capital, unravel how they are related, and underscore the importance of managing both to make informed, strategic decisions that help your business grow.

What is Cash Flow?

Cash flow is the lifeblood of any business, a dynamic and telling sign of its financial health. It encapsulates the movement of funds into and out of your business's coffers over a specified timeframe, be it monthly or yearly. This includes all forms of income – sales revenue, investment income, received loans, and any other cash inflows. Similarly, it encompasses all expenses, encompassing operational costs, debt repayments, and capital expenditures, regardless of the payment mode employed.

A robust cash flow doesn't merely imply a surplus of income over expenses; it is the rhythm that enables businesses to thrive. Positive cash flow indicates that a company is well-positioned to settle its debts, reinvest in its operations, pay out dividends, and buffer against future financial challenges. Conversely, a negative cash flow could signal potential distress, an alarm that the business may be overspending or failing to generate adequate revenue.

Understanding cash flow is paramount, not just for maintaining solvency but also for laying the foundation for growth capital. It's a critical measure that investors and financial institutions scrutinise to assess a business's performance and long-term viability.

What is Working Capital?

Working capital is the financial value of the investment in the things that generate profit and cash for a business. It will include:

  • Trading Stock / Work in Progress / anything else you purchase and/or transform to sell to clients

  • Accounts Receivable / Debtor balance - you've sold the goods/services and this is the cash owed to you

  • Accounts Payable / Creditor balance - value of credit extended by your suppliers

  • Cash - you'll use your cash to pay suppliers as their invoices fall due

The total value of Working Capital is a primary metric that serves as a snapshot of your company's operational efficiency and short-term financial health. It is calculated by subtracting current liabilities from current assets. These assets include cash at hand, inventory, and accounts receivable, which are expected to be liquidated within the fiscal year. Current liabilities, on the other hand, comprise obligations such as accounts payable and short-term debt.

This metric isn't just a number on a balance sheet; it's a reflection of a company's ability to weather financial storms and capitalise on immediate opportunities. To boost your working capital, strategies such as improving inventory management, renegotiating payment terms, and making use of working capital financing solutions are essential. Companies with ample working capital can ensure smooth daily operations, invest in new projects, and improve their bargaining position with creditors.

The Symbiotic Relationship between Cash Flow and Working Capital

How are Cash Flow and Working Capital Related?

Consider a thriving Sydney café; every coffee sold contributes to cash flow, impacting the café's ability to purchase beans and pay staff—its working capital. The cash from sales (cash flow) determines if the café can cover its immediate expenses (working capital). A consistent positive cash flow generally translates to healthy working capital levels, enabling a business to invest in innovation, like launching a new line of gourmet sandwiches or expanding seating capacity.

Yet, cash flow is not always a predictor of working capital health. For instance, a business may show a positive cash flow after selling off assets or securing funding, but this doesn't necessarily mean it has the working capital to sustain day-to-day operations. Inversely, a company might have substantial working capital tied up in inventory, unrevealed in cash flow figures, potentially skewing a financial analysis.

Let's take a closer look at that Sydney Café

Our Sydney Café is an in-house café for the large consulting firm "PWB". It supplies coffee and meals to PWB on 14 day payment terms. They sell about $1,000 per day to PWB, order stock once a week and their supplier payment terms are 7 days. Their working capital investment excluding cash is:



14 day terms = 2 weeks worth of sales owing from PWB at any point in time



Maximum stock value is 1 week's worth of stock



Supplier payment terms are 7 days = a single week's stock order


Working Capital = Debtors + Stock - Creditors

Now let's compare its sister Café in Brisbane

Our Brisbane Café is an in-house café for another big consulting firm "EZ". They also sell $1,000 each week but run things slightly differently in the Sunshine State - EZ has a 7-day payment term, and the café orders stock twice weekly. Their working capital investment excluding cash is:



7 day payment terms = 1 week's worth of sales owing from EZ at any point in time



maximum stock value is 1/2 week's worth of stock



7 day supplier payment terms and 2 orders per week = a week's worth of supplier invoices open at any point in time


Working Capital = Debtors + Stock - Creditors

Which café would you rather own?

(dont cheat, the answer is further down this article)

Which café would you rather own?



Businesses must ignite their company growth by maintaining a delicate balance between cashflow and working capital. A sound strategy involves meticulous cash flow management, ensuring that cash inflows exceed outflows, and prudent working capital management, guaranteeing that the business can fund its short-term obligations and operational needs.

What's the Difference Between Cash Flow and Working Capital?

To draw a clear line between cash flow and working capital, we can liken it to the relationship between the heart and the blood in our bodies. If cash flow is the heart—pumping money through the business—then working capital is the blood, the resource itself that is circulated. While cash flow reflects the movement, working capital represents the resource necessary for immediate use.

Cash flow measures the ability of a company to generate value over a period, indicative of its potential to thrive and expand. It's a component critical in the evaluation of long-term strategy, affecting decisions on investments, dividends, and funding requirements. On the other hand, working capital offers a snapshot of the company's short-term financial health and operational efficiency.

This differentiation is pivotal, as it allows business owners to apply strategies like using the working capital ratio to gauge their ability to cover short-term liabilities with short-term assets. It's a clear metric that can indicate the need for immediate action, such as adjusting credit terms or seeking short-term financing, to avoid liquidity issues.

The Importance of Understanding Both Metrics

For any business, especially those navigating the often volatile Australian market, the importance of distinguishing between cash flow and working capital cannot be overstated. Each provides distinct insights into the financial health of a company. A business may exhibit a healthy cash flow, yet lack the working capital necessary to take advantage of bulk-buy discounts from suppliers. Alternatively, it could have considerable working capital but struggle with cash flow due to customers delaying payments.

Recognising the differences equips business owners with the knowledge to seek appropriate financial solutions. In cases where working capital is abundant but cash flow is negative, strategies like invoice financing or working capital loans can bridge the gap, providing the cash injection needed to keep the business afloat.

Here's the answer: the best Café to own is ...

Brisbane !

Brisbane has $8,167 less investment in working capital than Sydney.

And where is that $8,167? It's in CASH. If two businesses are earning the same and have the same cost base, efficient working capital management actually puts cash back in the business quicker.

In this example you can actually see which levers were pulled to reduce the amount of cash stuck in working capital:

  • Reduce debtor payment terms

  • Purchase stock inn smaller, more frequent orders

But they could have also:

  • Extended Creditor payment terms

These working capital levers are common to every business.

Navigating the Financial Seas: Strategic Implications and Conclusion

Strategic Implications for Business Owners

The Australian economic seascape is one of opportunity yet fraught with challenges that demand astute financial navigation. A clear understanding of both cash flow and working capital not only prevents businesses from running aground but also steers them towards profitable horizons.

A business might have positive working capital, yet if its cash flow is negative due to delayed payments or high operating costs, it risks stagnation or contraction. To counter this, strategies like improving payment terms with clients or restructuring debt can ensure a steadier cash flow.

Conversely, positive cash flow with insufficient working capital might indicate overreliance on short-term financial fixes, which could lead to instability. Here, a deeper analysis into the allocation of funds and working capital management may be necessary to ensure the business doesn't just survive but thrives.

Conclusion: The Dual Compass of Financial Health

As we chart the course of a business's journey, cash flow and working capital are the twin compasses guiding us through the economic currents. Both metrics are vital: one measures the flow, the other the capacity. They are the yin and yang of financial health, each with its distinct role, yet intimately connected.

Cash flow is the narrative of your business's financial journey, telling the story of where your money is coming from and where it's going. It's an ongoing saga of transactions that can herald growth and success if positive or signal warning bells if negative.

Working capital, by contrast, is the snapshot of your business's ability to meet its immediate and short-term obligations. It's the financial cushion that allows for operational ease, enabling you to cover day-to-day expenses and providing the agility to respond to unexpected opportunities or challenges.

In essence, cash flow is about sustainability, while working capital is about solvency. A business requires a harmonious balance of both to not only stay afloat but also to sail towards expansion and profitability.

By monitoring both metrics with a keen eye, business owners can make informed decisions, whether it's time to tighten the sails or chart a course to new markets. This dual focus will ensure that the business remains buoyant, capable of navigating through calm and stormy financial waters alike.

In conclusion, remember that cash flow and working capital, while distinct, are interconnected in the dance of business finance. Keep a close watch on both, and you'll have the foresight and flexibility to lead your business towards a future of success and stability. Sail on with confidence, knowing that you're well-equipped to manage the ebb and flow of your company's financial tides.



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