Working capital

Working capital represents the cash available to fund ongoing operations after meeting short-term obligations. Positive working capital means the company has more short-term assets than short-term liabilities and can comfortably cover its near-term obligations. Negative working capital means short-term liabilities exceed short-term assets, which may indicate liquidity stress.

Current assets typically include cash, accounts receivable, inventory, and prepaid expenses. Current liabilities include accounts payable, accrued expenses, short-term debt, and the current portion of long-term debt.

For SaaS companies, working capital dynamics are often favourable because customers frequently pay upfront (monthly or annual subscriptions), creating deferred revenue that is a current liability but is backed by cash already collected. This means a SaaS company can have negative working capital by accounting standards while being perfectly healthy from a cash perspective.

Working Capital = Current Assets - Current Liabilities

Net working capital is often used interchangeably, though some definitions exclude cash and short-term debt:

Operating Working Capital = (Accounts Receivable + Inventory) - Accounts Payable

This operating version is more useful for understanding the capital tied up in day-to-day business operations because it excludes financial items that management can adjust independently.

The tree reveals the levers for managing working capital. Collecting receivables faster reduces the capital tied up in outstanding invoices. Negotiating longer payment terms with suppliers extends the time before cash leaves the business. Reducing inventory (for product businesses) frees up capital that was locked in unsold goods. Each lever connects to a different operational function.

Working capital requirements vary dramatically by business model. Capital-light SaaS companies may need very little working capital because cash is collected upfront and there is no inventory. Manufacturing and wholesale businesses may have 20-30% of revenue tied up in working capital because of inventory and receivables cycles.

The working capital ratio (current assets / current liabilities) is a useful normalised measure. A ratio above 1.5 is generally considered comfortable. Between 1.0 and 1.5 is adequate but requires monitoring. Below 1.0 indicates potential liquidity risk, though this can be normal for businesses with predictable cash flows like SaaS.

1. 1

   Accelerate receivables collection

   Reduce days sales outstanding (DSO) through earlier invoicing, automated payment reminders, and incentives for early payment.

2. 2

   Extend payable terms

   Negotiate longer payment terms with suppliers to keep cash in the business longer. Standard terms of 30 days can often be extended to 45 or 60 days.

3. 3

   Encourage annual prepayment

   For subscription businesses, incentivise annual prepayment with discounts. This brings 12 months of cash in upfront, dramatically improving working capital.

4. 4

   Reduce inventory levels

   For product businesses, improve demand forecasting and implement just-in-time processes to reduce the capital tied up in unsold goods.

1. 1

   Treating negative working capital as always bad

   SaaS companies with large deferred revenue balances often have negative working capital by accounting standards while being cash-rich. Understand the composition before reacting.

2. 2

   Ignoring working capital in growth planning

   Growing businesses often need more working capital as receivables and inventory increase. Failing to plan for this can create cash crunches during periods of rapid growth.