A few years ago, I started my own skincare business. Like many first-time business owners, I spent most of my time thinking about the product. We had something we believed in, customers were buying from us, and there was always another idea we wanted to work on.
What I failed to realise at the time was that there was another part of the business quietly influencing almost every decision we made.
Finance.
Not in the sense of preparing financial statements or calculating ratios, but in understanding how money actually moves through a business.
If I’m being completely honest, I never gave much thought to working capital. And even after hearing the term for the first few times, I didn’t really understand why it mattered. It was simply another business phrase that sounded important.
Recently, I found myself thinking about it again. But this time, instead of asking, “What is working capital?” I found myself asking a much more interesting question.
Why does every business seem to care so much about it?
That simple question completely changed the way I looked at working capital.
If we forget all the accounting terms for a moment and simply think about running a business, our objective is most likely going to be quite straightforward. We want our business to grow. We want to make more sales. We want to make a profit. At the same time, we also want to have enough cash to keep the business running every day.
Those two objectives sound as though they should naturally go together. I mean, if the business is doing well and making more profit, surely everything should be fine.
But that’s exactly where working capital starts to matter.
Let’s imagine we are running a manufacturing company. If our goal is to grow our business, then ultimately we need to sell more products. That’s the obvious answer. But selling more products isn’t just about having a better product or better marketing. It’s also about being able to deliver when customers are ready to buy.
Imagine you’re looking to buy a new coffee machine. One company tells you they can deliver tomorrow because they already have inventory available. And another company tells you they’ll need another three or four weeks because production hasn’t started yet. I’m sure most of us would probably choose the first company. From the customer’s perspective, that’s an easy decision.
I used to think of inventory as just products sitting in a warehouse. Now I see it a little differently. Inventory means shorter lead times. It’s faster delivery. It’s giving customers what they want when they want it.
Sometimes, that’s exactly what wins the sale.
Now, imagine two suppliers selling almost identical products at similar prices. Supplier A asks you to pay within seven days and Supplier B gives you sixty or even ninety days. If you were running a business yourself, which supplier would you be more interested to work with? Most of us would probably choose the one offering longer payment terms because it gives us more flexibility with our own cash.
That’s why businesses often offer credit to their customers. It’s not simply about waiting longer to receive money. Sometimes it’s part of staying competitive. Sometimes it’s what helps build long-term customer relationships.
At this point, it almost feels as though everything is quite simple.
Keep more inventory. Offer longer credit terms. Support more sales. Problem solved.
Except it isn’t.
Because every decision has another side to it. Every extra product sitting in a warehouse has already been paid for. That money can’t be used somewhere else. Warehouses cost money. Insurance costs money. Some products become outdated before they’re sold.
The same thing happens with receivables. The longer customers take to pay, the longer our cash is tied up inside the business. Some customers pay late. Some never pay at all.
This is essentially what working capital captures:
Working capital = Current assets − Current liabilities
Inventory, receivables and cash are all part of current assets. From these, we deduct the short-term obligations the business needs to meet, such as amounts owed to suppliers.
The formula itself is simple. The decisions behind it are not.
The objective has never been about maximising working capital. The objective is to find the right balance.
Enough inventory to support sales. Enough flexibility to keep customers happy. But not so much that unnecessary amounts of cash become trapped inside the business.
Then, how do companies know where that balance is?
How do they decide whether they should keep more inventory or less? How generous should they be with customer credit? How much cash should they keep available?
Well, it depends.
A seasonal business preparing for Christmas probably needs far more inventory than it normally does during the rest of the year. A manufacturer producing customised machinery may make completely different inventory decisions from a supermarket that can restock its shelves every day.
Even competitors influence these decisions. If everyone in your industry offers customers sixty days to pay, deciding to offer only seven days might make it much harder to win new business. On the other hand, if customers are happy to pay immediately because demand is strong, there may be little reason to offer long credit terms at all.
The same applies to suppliers. If they’re reliable and can deliver whenever you need them, you probably don’t need to hold as much inventory. But if deliveries are unpredictable or materials take months to arrive, keeping extra inventory suddenly starts to make a lot more sense.
Once management has considered all of these factors, another decision still remains.
Where should we actually put our money?
Let’s say we have another €100,000. One option is to use that money to buy more inventory. Maybe we keep a little more cash in the bank as well, just in case something unexpected happens.
But is that necessarily the best use of the money? What if that same €100,000 could be used to buy a new machine instead?
If that machine allows us to produce more products, reduce production costs or improve efficiency, wouldn’t that create more value for the business than simply having more inventory sitting in the warehouse?
On the other hand, what if demand suddenly doubles next month? Or one of our suppliers can’t deliver on time? Would we wish we had kept that extra inventory after all?
Neither policy is right. Neither policy is wrong. Management is simply deciding where they believe that €100,000 will create the most value.
Some businesses will choose to invest more of that money into growth. Others will prefer to keep a larger cushion of inventory or cash in case something unexpected happens.
The best decision depends entirely on the business, the industry it operates in and what management believes is the best use of its resources.
Perhaps that’s what I’ve come to enjoy most about finance.
Working capital isn’t really about inventory, receivables or cash. It’s about deciding where limited resources can create the most value while accepting that we’ll never know for certain whether we’ve made the perfect decision.
Every choice comes with a trade-off. Every euro invested in one place is a euro that can’t be invested somewhere else.
Working capital is one of the places where those decisions become visible.
