Working capital vs. cash flow: why you need to know the difference

When growing your small business, it’s important to have a firm understanding of your finances. Two of the most important numbers to consider are your working capital and your cash flow. While these figures are related, they aren’t identical. Figuring out each one can help you analyze the health of your business and what steps you need to take in order to ensure future growth.

What is Working Capital?

To determine your working capital, you simply need to subtract your current liabilities from your current assets. How do you know which ones are current? Typically, the assets should have the ability to be liquidized within a year and the liabilities are anything that’s due within a year. In order to have ample working capital, you need to be able to have enough liquid assets on hand to cover those liabilities. If you’re in the negative, you don’t have the ability to cover those short-term debts, which can be a risky situation.

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What Is Cash Flow?

Cash flow is the amount of money your business brings in during a certain time. It’s liquid and can be reinvested into the business. Many lenders request a cash flow statement, so it’s important to understand exactly what this entails. Typically, the following income is included as part of your company’s cash flow calculations: operations, interest, amortization, and depreciation. All of this can be used to pay existing financial obligations, such as payroll, creditors, and other expenses.

How Are They Related?

Understanding the difference between working capital and cash flow helps to get a true sense of how well your business is performing. Oftentimes, the two numbers are related. After all, if you have a lot of cash flow, you probably have enough working capital on hand to cover your liabilities. But if you made a large financial investment in order to spur that growth in cash flow, you may actually be working hard to maintain positive working capital.

The Bottom Line

Taking out a working capital loan can help balance your assets and liabilities while adding to your cash flow. When used strategically, you can pay off a short-term loan quickly to remove the liability, while potentially reaping the benefit of having extra cash on hand for growth or daily operations.