Why Cash Flow Is Not the Same as Working Capital

If you sell 90 percent of your inventory, that’s a pretty good number. However, if the revenue doesn’t cover the cost of the loan you took out to purchase said inventory, those sales are a little less meaningful. This is why it’s important to understand the difference between cash flow and working capital. In order to have a solid grasp of your company’s profits and what you can do with cash as it comes in, you need to see the whole picture.

Spend or Save?

If you take out a $20,000 loan to pay for restaurant equipment, every five dollars you make on a sandwich is essentially money that you don’t have until that lender is full reimbursed. This is a difficult concept for most business owners; money generated is seen as profit to be spent on overhead so that the business can keep running. In reality, your cash flow can be severely limited by your working capital ratio, as the worth of your assets should always be higher than the worth of your liabilities. In order to avoid falling further into debt, cash earned should be put towards balancing your company’s books whenever possible.

Which Is More Important?

You can’t really declare that having cash on hand is more important than assets outweighing debts, or vice versa. Any business needs sales to bring in cash flow and stay alive. Similarly, owing too much money to lenders can eventually lead to bankruptcy. The only arena in which working capital trumps cash flow is during the times when cash stops flowing, due to economic hardships or a simple slow period for your business. When money isn’t coming in, you need to have enough assets to offset debt payments without having your business become totally hamstrung by a lack of capital.

The word “working” can cause a bit of confusion, as the money doing the most “work” is always the cash you bring in and use to pay for expenses. At the end of the day, what’s most important is that business owners keep track of what they owe, what they’re spending, and what they’re bringing in – and then do their best to balance all of it.

A summary of your company’s profits always looks better when there isn’t a huge amount of debt looming over it. If you can keep your working capital ratio where it should be, your business will have a much better chance of surviving the ebbs and flows of cash.

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