Working Capital: The Lifeblood of Daily Business Operations
By Mike Brandon, Managing Director at Merchant West Working Capital Solutions
Working capital is the financial fuel every business needs to operate effectively on a daily basis. It provides the necessary liquidity to purchase inputs, maintain inventory, manufacture goods or deliver services, and bridge the cash gap between paying suppliers and receiving payment from customers.
Put simply, working capital keeps a business running between cash inflows and outflows. Without it, even profitable businesses can stall due to cash shortfalls.
How Do Businesses Finance Working Capital?
There are several ways to fund working capital, each with its own trade-offs:
- Supplier Credit: Many suppliers offer trade terms that allow businesses to pay later, effectively financing purchases in the short term. This is often a low-cost solution, though suppliers typically factor the cost into their pricing and may reduce flexibility—especially in international trade.
- Customer Prepayments: Advance payments or deposits from customers provide upfront cash flow. However, these arrangements often come with discounts or require strong customer trust and negotiation power.
- External Funding: Most businesses rely on third-party financing to meet working capital needs. Lenders such as banks or specialist financiers like Merchant West provide structured facilities to help businesses manage payment cycles, stock levels, and customer terms in a way that enhances competitiveness and supports growth.
A well-structured working capital facility ensures operational stability, protects margins, and enables a business to seize opportunities as they arise.
What Are the Main Types of Working Capital Finance?
The most common funding methods include:
- Overdraft Facilities: Flexible and quick to access, overdrafts are often secured against the business’s overall financial standing. While useful for short-term gaps, overdrafts can be expensive and may not grow in line with business needs—especially in the early stages of expansion.
- Short Term Asset-Based Finance: A more scalable and tailored approach. This includes:
- Stock or Inventory Finance: Uses existing stock as collateral to fund inventory replenishment.
- Invoice Discounting: Advances cash against outstanding invoices, unlocking liquidity tied up in the debtor book.
These solutions are dynamic—growing as the business grows—creating a virtuous cycle of increased funding capacity alongside rising sales and stock volumes. Merchant West specializes in structuring such solutions, leveraging short-term assets as transactional security.
How Is Working Capital Efficiency Measured?
The most common metric is the Cash Conversion Cycle (CCC):
CCC = DPO – DIO – DSO
- DPO (Days Payable Outstanding): The average time the business takes to pay suppliers (a cash inflow).
- DIO (Days Inventory Outstanding): The average time inventory is held before being sold.
- DSO (Days Sales Outstanding): The average time customers take to pay (a cash outflow).
A shorter CCC indicates a more efficient cycle, reducing the number of days a business must fund operations without incoming cash.
What’s the Best Type of Funding for Working Capital?
The ideal match is short-term funding. Many businesses make the mistake of using long-term loans to fund short-term needs, which can restrict liquidity for growth initiatives. Conversely, using short-term funds to buy long-term assets can create cash strain and increase refinancing risk.
Merchant West provides expert guidance to help businesses align their funding with asset life cycles – ensuring optimal use of capital.
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Working Capital Solutions
Frequently Asked Questions
Working capital is the money a business uses to fund its day-to-day operations. It covers costs such as inventory, supplier payments, and customer credit.
Calculate the Cash Conversion Cycle (CCC). A shorter CCC generally indicates greater efficiency. Review how long it takes to convert investments in inventory and receivables into cash.
It’s generally not recommended. Long-term loans are better suited to fixed asset purchases. Using them for working capital can reduce financial flexibility and tie up funds unnecessarily.
Invoice discounting allows businesses to unlock cash tied up in unpaid invoices. It improves liquidity without waiting for customer payments, supporting smoother operations.
Companies with significant inventory or receivables—such as importers, wholesalers, manufacturers, and distributors—are ideal candidates. Asset-based finance scales with business growth, providing a sustainable source of liquidity.
