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How working capital differs from cash flow

Working capital versus cash flow: Learn how they differ and how each benefits your business. Presented by Chase for Business.

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    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 and discover new growth opportunities. But even brisk sales, sold-out product lines or stacks of signed client contracts don’t always equal financial stability.

    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.


    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 measure 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 increase cash flow include reducing operating costs, selling an asset or more swiftly collecting accounts payable. Some businesses employ a combination of these and other approaches. Need some ideas for creating positive cash flow? Check out this article.


    What is working capital?

    Your company’s working capital is the difference between its current assets and its 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.

    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.

    Businesses with a healthy working capital ratio of assets to liabilities are more likely to withstand these disruptions to stay in business. Whenever possible, it’s best to keep this working capital ratio higher than 1-to-1. 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. Need strategies for increasing positive working capital? This article can help.


    How working capital and cash flow differ

    The primary difference? 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.

    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.



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