One of the least understood financial measures, at least by the business owners I work with, is their working capital requirement. When examining accounting records, it is simply the business recievables plus inventory, subtracted from payables and payroll liabilities (with some minor exceptions). It’s called working capital requirement because many businesses are required to use internal money to support this spread. In other words, money is tied up waiting for customers to pay up(receivables), and also tied up in inventory. This is subtracted from the fact that you owe your vendors money, which effectively becomes your bank.
In some rare cases, such as some retail businesses, working capital is a negative number. This means that the working capital cycle produces cash; products are sold to customers before they’re paid for. Several years ago Home Depot insisted that all vendors get paid when the product is rung up at the cash register. This brilliant move essentially removed all inventory from the operation, giving Home Depot a tremendous advantage.
How you finance this lack (or difference) in cash is debatable, but knowing and tracking your working capital requirement is important because it can help resolve cash flow issues. Like many topics related to small business financial excellence, it goes back to a decent accounting system and an eye for details.