What is working capital?

Take the latest balance sheet and BAS reports, add up the current assets, add up the current liabilities and subtract. Current assets are the items expected to turn into cash within 12 months: cash, trade debtors, inventory, prepayments and GST receivable. Current liabilities are what falls due in the same window: trade creditors, accrued expenses and payroll liabilities, the short-term portion of loans or overdrafts, GST payable and other tax and superannuation liabilities.

The quality of the assets matters as much as the total. Overdue receivables and obsolete stock count in the figure but are far less liquid than cash, so track each component separately: receivables collection, inventory turnover and supplier terms each move cash in a different way.

The current ratio is current assets divided by current liabilities; above 1.0 means current assets cover what is due. Typical SME targets sit between 1.2 and 2.0, though fast-turnover retailers run lower and professional services often higher, and a ratio above 2.0 can mean idle assets. The quick ratio drops inventory and prepayments and tests whether cash, receivables and short-term investments alone cover current liabilities.

The cash conversion cycle counts the days cash is tied up: days inventory outstanding plus days sales outstanding minus days payables outstanding. Average inventory of $50,000 on cost of sales of $360,000 is about 50.7 days, receivables of $70,000 on credit sales of $600,000 about 42.6 days, and payables of $90,000 about 91.3 days, giving a cycle of roughly 2 days. Lower or negative is better. Ratio analysis covers the wider set.

Quick wins: invoice on the day of delivery with clear terms, credit-check new customers and set limits, offer early-payment discounts where the margin allows, trim inventory with reorder rules and safety stock matched to lead times, negotiate longer supplier terms and defer non-essential capital spending. Medium term: automate reminders, e-invoicing and direct debit, link sales forecasts to receivables and payables ageing in a cash flow model, and time payroll and BAS commitments with the ATO's guidance in mind.

When operations alone are not enough, an overdraft gives a flexible buffer, invoice finance or factoring turns unpaid invoices into cash, a line of credit smooths seasonality, a working capital loan or other short-term loan covers one-off needs, and a merchant cash advance draws on future card takings quickly but at a high cost. Weigh cost, flexibility and the effect on the balance sheet, and check with your accountant.

Some businesses run negative working capital by design: retailers and marketplaces that collect from customers before paying suppliers, event and subscription businesses funded by deposits and prepayments, and high-turnover operators with strong supplier terms. Supermarkets and some subscription models are the classic cases.

The risk is that the position depends on other people's behaviour. If suppliers tighten terms or customers pay more slowly, a strategic negative position becomes solvency stress, and heavy reliance on short-term finance adds cost and refinancing risk. Working capital is also only a snapshot: off-balance-sheet leases and contingent liabilities, one-off receipts and BAS timing can all flatter or distort it, so read it with a cash flow forecast.