"If your working capital is negative, it usually indicates that your business is struggling to make ends meet."

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What causes regular working capital shortages?

When a business has more current liabilities than current assets, it has negative working capital. And when this happens it may struggle to stay afloat during tough economic times or fund growth projects.

A number of factors can make your working capital go negative, including production bottlenecks in manufacturing creating longer delivery times, increases in raw material and labour costs, or if the delivery of goods or services is faster than receipts of revenues. Another common cause is succumbing to pricing pressure from customers or competitors.

If your working capital is negative for an extended period, it usually indicates that your business is struggling to make ends meet. This may force you to rely on borrowing or equity issuances to finance your working capital.

Cash is king

If you do not have adequate cash reserves to weather a short-term cash emergency, or have not planned on how to run your business during such a period, you may struggle to maintain a healthy cashflow in the longer term.

Working capital can serve as an indicator of how a company is operating. When there is too much working capital, more funds are tied up in daily operations, signalling the company is being too conservative with its finances. Conversely, when there is too little working capital, less money is devoted to daily operations—a warning sign that the company is being too aggressive with its finances.

What are the key indicators?

Having a dashboard of financial indicators can help you monitor your working capital, enabling you to spot warning signs and prevent any long-term damage to your business. Typical warning signs can include having limited cash available or evidence of habitual overdraft borrowing.

You may notice debtor days increasing or creditor days reducing, or have heightened levels of stock and work in progress (WIP).

Managing Director/CEO

The Managing Director/CEO needs to take control of the emerging situation by holding emergency Board meetings to review likely causes. It is valuable time spent reviewing existing KPIs to evaluate appropriateness and revisiting business funding lines to assessing whether these remain fit for purpose.

Financial Director

The Financial Director needs to take responsibility for identifying internal and external solutions to mitigate the short-term deficiency in cash flow. This can be achieved by reviewing pricing policy and adjusting where appropriate, as well as tracking collection times with customers to identify which are slow payers can also help.

Forming tighter relationships with creditors and negotiating better creditor terms and focusing on timely debt collection should be on the FD’s to-do list. Also on that to-do list should be a thorough review of stock levels and production efficiencies. The FD should also consider options such as seeking an increased overdraft, recapitalising the business and shareholder support or leasing.

Sales and Operations

The Sales and Operations teams need to work collaboratively to support the MD and FD. The focus here should be assisting the MD/FD in reviewing and addressing the above issues. Having up to date reporting on pricing policy and the capacity for the market to accept price/rate increases will be valuable information. And arguably of more importance in a manufacturing context, the sales and operations teams need to ensure the production process is running as efficiently as possible.

Key points

It is really important to review your existing funding lines to see if they are still relevant. For example, have you utilised working capital lines for capex or investment purposes? You may wish to consider how funding lines can be reorganised to create sufficient headroom and conduct cashflow modelling to determine the long-term working capital needs of your business.

We work with growing UK SMEs and small-cap PLCs that have funding needs in excess of £2m and regularly approaching £100m. Our clients’ needs will typically be for sophisticated finance products such as cash flow based lending or private equity investments. Our value lies in helping clients access funding that relies on confidence in future trading and cash flows. For a confidential, independent, no obligation discussion on the funding options available click the 'Let's chat' button.