How working capital differs from cash flow

As a small business owner, you’re probably already measuring the overall financial health of your business. Monitoring inventory, counting the cash drawer and keeping daily tabs on sales are effective ways to measure profitability. But to truly gauge your company’s health, it’s best to look at two aspects of your company’s finances: cash flow and working capital.

You probably know how critical cash flow is because you see those numbers on balance sheets after close of business. But understanding and measuring working capital is important, too. Together, cash flow and working capital provide an excellent snapshot of your company’s health: its current needs, growth potential and sustainability. However, since working capital and cash flow seem to measure and indicate similar things, some entrepreneurs mistakenly assume they’re interchangeable. They’re not. Read on to learn more about the difference between working capital and cash flow.

What is cash flow?

Simply put, cash flow refers to the amount of cash that moves in and out of your company during a specific time frame — how much your business is earning versus how much you’re paying to stay in business (in overhead, to vendors, etc.). Ideally, your cash flow is positive, which means you’re earning more money than you’re paying out during a specified period. Naturally, negative cash flow means your business is spending more money than it’s bringing in. A few months of negative cash flow won’t necessarily ruin your business, but you should be aware if you’re experiencing this and have a strategy in place for moving cash flow back into the positive column.

There are several ways to calculate cash flow, whether you want a simple snapshot or a wide-angle picture of your financial situation. Many businesses use an online tool to measure it.

Steps you can take that could help improve cash flow include reducing operating costs, establishing an emergency cash reserve or more swiftly collecting accounts payable. Some businesses employ a combination of these and other approaches.

What is working capital?

Working capital is usually a measurable forecast over a short term, the next 12 months in most cases. Essentially, it measures how readily your business could withstand an unforeseen drop in sales or an unanticipated disruption in your market. Recent weather events and supply chain issues, for example, have demonstrated how volatile today’s market can be for businesses of all sizes in just about every sector.

Your company’s working capital is the difference between its current assets and its current liabilities or debts. Assets are either cash on hand or financial instruments, including investments and bonds, as well as anything that can be liquidated for cash, such as office or business equipment or inventory. Liabilities or debts include loans, outstanding accounts payable and accrued expenses.

Businesses with a healthy working capital ratio of assets to liabilities are more likely to withstand these disruptions to stay in business. Maintaining a ratio between 1.0 and 2.0 generally means your business has a healthy level of liquidity. It’s important to note that a ratio greater than 2.0 might suggest inefficient resource management, while a ratio lower than 1.0 can lead to a potential liquidity problem. Another reason to keep this top of mind is that lenders will look closely at your working capital, and that amount could influence how they view your company’s financial health.

Working capital vs. cash flow: How do they differ?

There is no such thing as “working capital cash flow” — they are two different, but related, terms. The primary difference between the two? As you’ve probably discovered, working capital gives you a snapshot of your company’s current financial health — insight about how quickly your company can withstand unforeseen market disruptions. Cash flow is more forward-looking, showing how much cash your business generates over a specific period. Your working capital can (and usually will) fluctuate, but it’s not a measurement you’d use to make projections about your company’s future solvency. Think of them as different lenses through which to view your business: Cash flow gives you the big picture of your cash intake and outlays, while working capital focuses on your company’s ability to withstand unanticipated yet constant market tumult.

Cash flow

Working capital

Naturally, there are exceptions. For instance, a company that’s generated high revenues while also carrying high levels of debt might have positive cash flow, but very little working capital. Conversely, a new business may have a large amount of working capital (through an initial investment or funding, for example) but is so new that it hasn’t yet generated either positive or negative cash flow.

It’s just as important to know your company’s working capital as it is to keep on top of your cash flow. Each one potentially affects the other, which affects your company’s sustainability and success. Need more insight? Chase can show you how to take steps toward future-proofing your business. Or speak with a business banker to find out how you can keep your business operational and financially stable.

Cash flow vs. working capital FAQs

How does working capital affect cash flow?

Increases in working capital reduce cash flow and vice versa, because the amount of available assets and current liabilities impacts the amount of cash a business has access to.

Is working capital the same as cash flow?

Working capital and cash flow are not the same, but they are related. Cash flow is the money coming into and out of your business which is more of a big picture perspective, while working capital is specifically looking at your business’s ability to pay current expenses by using current assets.

Why are both working capital and cash flow important for a business’s financial health?

Both working capital and cash flow are important because they reflect how well your business is doing on a day-to-day basis. An unhealthy cash flow and lack of working capital means your business is struggling when it comes to maintaining healthy finances.