WORKING CAPITAL VS. CASHFLOW EXPLAINED

Good accounting is a priority whether you’re a small business or a Fortune 500. Understanding your company's financial health helps you make more informed decisions, including differentiating between working capital and cash flow.

Working capital and cash flow do interplay, and while they might seem to have some overlap, they look at two distinct metrics. Once you grasp the essential function, they’re relatively easy to take measures and monitor.

Cash Flow

Cash flow is the money that is flowing through your company. Usually, this is represented over a specific period. For most companies, it tends to be in thirty-day increments, as it gives the best balance between the big picture and the small picture. It’s important to note that cash flow doesn’t give you your net profit. Instead, what you’re getting is the liquidity of your business.

There are two ways of calculating cash flow from operating activities: direct and indirect. The direct method is a broadly accurate picture of your day-to-day cash and the method most often used.

Cash Flow from Operating Activities = Total Revenue - Operating Expenses

For example, if the Total Revenue is 100 USD and Operating Expenses are equal to 80 USD, the Cash Flow from Operating Activities equals 20.

Working Capital

Working capital is the overall operating money that your company has available minus debts. Businesses need access to positive working capital, which helps insulate the business against unexpected events.

In short, Cash Flow pays for expenses and is evaluated daily, weekly or monthly. Working Capital pays for investments in the business and is assessed over the year.

Working capital = Current Assets - Current Liabilities

If the Current Assets are equal to 50 and the current liabilities to 40, the working capital is equal to 10.

Different companies will make other investment decisions of capital. But all companies must spend money properly. For business, the only thing more valuable than cash is capital. A company must use it wisely.

Working capital expenditures are classified into three categories:

1. Replacement and upgrade

2. Innovation

3. Growth opportunity

How Cash Flow Affects Working Capital

A company’s cash flow directly affects its amount of working capital. If revenue declines and the company experiences negative cash flow, it decreases the working capital.

When a business needs to increase its working capital, tactics to bridge that gap involve either adding to current assets or reducing current liabilities.

Conclusion

On working capital, consider how you are investing in your company. Are you purchasing equipment and products essential to operations and business growth? Also, think about whether it is the right time to acquire debt or if you are reaching too much long-term debt that will be difficult for your business to repay.

Lastly, the best way to manage working capital and cash flow is to have accurate financial records throughout the life of your company. Monitoring cash flow and working capital help determine the likelihood of surviving a financial emergency. 

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