What’s the Real Difference Between Working Capital and Cash Flow?

It’s critical for small business owners to be acutely aware of their company’s financial health. But it’s also crucial for them to understand what creditors and would-be lenders use to evaluate a business’ finance. Two key factors are working capital and cash flow.

What is working capital?

Working capital is the amount of money your business has to operate after debts are considered and accounted for. This money, however, is not just figured in terms of liquid cash. It also factors in assets such as equipment, inventory, and even investments.

What is cash flow?

 

Cash flow is a simpler calculation than working capital as it looks solely at income and expenditures: cash coming in, and cash going out.

 

What is the difference?

An easy way to frame the difference between working capital and cash flow is that working capital is a bigger picture, or macro, consideration, while cash flow is a more short-term, or micro, measure. Cash flow shows how much money your company is generating, and also how much you have on hand to reinvest in the business. Working capital displays your ability to cover immediate liabilities.

How do they affect my business?

Working capital fluctuates over time, but it paints an accurate picture for creditors of your business’ financial situation. It shows them also how you take in revenue and spend money, demonstrating how likely you would be able to stay open in the face of a downturn in sales or catastrophic event like a natural disaster.

A basic metric for working capital is called a “current ratio.” The current ratio is figured by dividing current assets (including assets other than cash as we mentioned before) by current liabilities. If the number is “1” or higher, you have a “good” or positive current ratio. A number lower than 1 shows a negative current ratio.

A negative current ratio will show lenders that you’re less equipped to handle a rough time in business, and they will factor that into funding decisions. A positive current ratio, on the other hand, will tell an appealing story to lenders and investors.

While it’s always important to know your cash flow status, it is critical that you are aware of your working capital and current ratio when looking to expand, borrow, or refinance. You must also understand how the two elements can impact and affect each other.

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