Good morning everyone. Today, we are going to talk about something very important in business finance called working capital. Now, do not worry, it might sound technical, but it is actually very simple and practical. It helps us understand whether a business can keep running smoothly from day to day.
So, what exactly is working capital? It is the money a business has available to pay its short-term bills and keep operating normally. We calculate it by subtracting current liabilities from current assets. In simple terms, working capital equals current assets minus current liabilities.
Current assets are items that can be quickly turned into cash, like money in the bank, stock ready to sell, or money owed by customers, which we call trade receivables. Current liabilities are short-term debts, such as money owed to suppliers, short-term loans, or wages that need to be paid soon. If a company has enough working capital, it can pay its bills on time, keep production going, and avoid financial stress. But if working capital is too low, the business might struggle to pay suppliers or delay paying employees, and in serious cases, it could even fail. This can happen even if the business is making a profit on paper.
Let’s imagine a small bakery. The bakery sells cakes every day but allows local cafes to pay after 30 days. This means the bakery has trade receivables, which is money that is owed but not yet received. Meanwhile, it must pay its supplier for flour and sugar next week. If the bakery does not have enough cash on hand, even though business seems good, it might struggle to pay the supplier. This example shows why managing working capital carefully is so important.
Now let’s look at two key parts of working capital: trade receivables and trade payables. Trade receivables, also called debtors, are customers who owe the business money. To manage this well, a business should set sensible credit terms, make sure it checks customers’ ability to pay, send invoices on time, and follow up on late payments. Getting paid on time helps keep cash flowing smoothly. On the other side, we have trade payables, also called creditors. These are suppliers that the business owes money to. Delaying payment a little can help the business hold on to cash in the short term, but waiting too long can annoy suppliers or cause the business to lose early payment discounts. So, businesses need to strike a balance between paying suppliers on time and maintaining enough cash to operate effectively.
Now, let’s talk about another important idea: the difference between capital expenditure and revenue expenditure. Capital expenditure means spending on long-term assets that the business will use for more than one year. This includes things like buying machinery, vehicles, or new buildings. These are big investments that help the business grow and are recorded as assets on the balance sheet. Revenue expenditure, on the other hand, means spending on everyday running costs. This includes paying salaries, electricity bills, or buying materials. These expenses are recorded in the income statement because they are used up within the year. It is important not to mix these up. For example, if you treat buying a delivery van as a small expense instead of a long-term investment, it can make your profit look smaller and give a false picture of your financial position.
In summary, working capital ensures a business has enough short-term funds to operate smoothly. Managing receivables and payables maintains healthy cash flow, while understanding capital and revenue expenditure aids financial planning. Effective working capital management is cr
