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Business Topics Money, Tax and Legal Money Matters Understand Your Accounts Balance Sheets
Components of a Balance Sheet Working capital

Working capital
1.
2.
3.
4.

What is working capital?

The working capital cycle
Whats the right level of working capital?
Working capital as a percentage of sales

What is working capital?

Working capital is the money needed to fund the normal, day-to-day operations of your business.
It ensures you have enough cash to pay your debts and expenses as they fall due, particularly
during your start-up period.
Very few new businesses are profitable as soon as they open their doors. It takes time to reach
your breakeven point and start making a profit.
Learn more about a breakeven analysis on the profit margin ratio page, or refer to Business
Victorias margin, markup and breakeven information and templates.

The working capital cycle

The working capital cycle measures the time between paying for goods supplied to you and the
final receipt of cash to you from the sale. It is desirable to keep the cycle as short as possible as it
increases the effectiveness of working capital.
The working capital cycle is made up of four core components:
1.
2.
3.
4.

Cash (funds available)

Creditors (accounts payable)
Inventory (stock on hand)
Debtors (accounts receivable)

Cash management
The key to successful cash management is to be in control of each step in the cycle. If you can
quickly convert your trading operations into available cash, you will be increasing the liquidity
in your business and will be less reliant on cash from customers, extended terms from suppliers,
overdrafts, and loans.
If possible, always try to get paid up front. If you invoice up front you can avoid the cost of
carrying others debts for months. For example, if your terms are 30 days and you invoice at the
end of the month, customers have between 30 to 60 days to pay. Youll also avoid losing money
from bank charges, because you may be going into overdraft while youre waiting to be paid.

Whats the right level of working capital?

The right level of working capital depends on the industry and the particular circumstances of the
business.
For example:
Businesses that only sell services, and do not need to pay cash for inventory need a lower level
of working capital. Businesses that take a substantial amount of time to make or sell a product
will need a higher level of working capital.
It is important you work out the right level of working capital you will need. If the working
capital is too:
1. HIGH
Your business has surplus funds which are not earning a return.
2. LOW
This may indicate that your business is facing financial difficulties.

The formula used to calculate working capital

Refer to balance sheet information before you get started, because you will need figures from
your most recent balance sheet.
working capital ($ value) = current assets - current liabilities
This calculation does not give you enough information about your working capital margin of
safety. To figure out if you have a wide enough margin of working capital for your business to
be in a healthy position (in terms of liquidity) you need to calculate the working capital ratio
(current ratio/liquidity ratio) of your business.

Working capital as a percentage of sales

Most business owners have a clear idea of their weekly, monthly, or quarterly sales levels, so
you may prefer to calculate how much working capital you need as a percentage of sales. For
example:

If you sell a lot of low-cost items and rapidly churn through your stock, you may only need 1015% of working capital for every dollar of sales.

If you sell high value/high priced items with a lower turnover, you may need 20-25% working
capital for every dollar of sales.

Your business may also sell items that fall somewhere between the two.

The formula used to calculate an estimate of working capital as a percentage of sales compares
the amount of working capital on the balance sheet to total sales, which youll get from your
profit and loss (or income statement), not the balance sheet. Learn more about the profit and loss
statement.
Working capital ($ value) = sales x (working capital as a % of sales)
For example:
Working capital as a percentage of sales of 35% means that you need $35 for every $100 of sales
to fund the sale to allow for the time delay in the working capital cycle.
For businesses going through a period of growth and expansion, this method is good for
calculating how much extra working capital you need if turnover increased by a certain amount.
The amount of working capital thats enough for your business, depends on sales revenues,
whether your business sells more services than products, if it carries high or low value stock, and
any plans for growth.

Whats next...

Book into an Understanding Your Business Financials workshop

Analyse your accounts using the liquidity ratios

Analyse your accounts using the efficiency ratios

Back to top

Top Tips

1. Dont be baffled by profit and loss statements, balance sheets or cash flow statements.
Make them work for you and book into an Understanding Your Business Financials
workshop
2. If youre thinking of starting a business, a start-up costing sheet can help you determine
how much money you need to start. Download our establishment expenses spreadsheet,
or refer to start-up costing and the start-up costing template at Business.gov.au.
3. Business.gov.au also provides practical information about business finances.
4. Learn how to set your prices at Business Victorias website, or try the Queensland
Governments online markup and pricing calculators.
5. Call 13 12 49 or email us to speak with a specialist small business adviser or visit us
and make the most of our one-stop service.
Business tools to download:
Breakeven analysis
Cashflow forecast
Cost of goods sold
Establishment expenses
Operating expenses
Sales forecast
Business guides to view:
Business plan template
Marketing plan template
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