What is working capital? The formula, the cycle and how to fund a gap

Working capital is the money your business needs to be able to operate from day to day. That is the British Business Bank’s definition, and its glossary adds that working capital is an indication of liquidity: it shows the business’s ability to meet its current obligations.

In practice it is the cushion between what the business holds in the short term (cash, stock and money customers owe) and what it owes in the short term (supplier bills, tax and loan repayments falling due). You may also see it called net working capital.

It is not the same as profit. A business can be profitable on paper and still be short of working capital, because the profit is sitting in unpaid invoices or unsold stock when the wages are due.

You calculate working capital by subtracting current liabilities from current assets: working capital = current assets − current liabilities. Both figures come from the balance sheet.

The table works through the sum for an imaginary business.

Notice where the £200,000 sits. Only £30,000 of it is cash. The rest becomes cash only when stock is sold and customers pay, which is why the headline figure can look comfortable while the bank balance does not.

The working capital ratio is current assets divided by current liabilities, and it tells you how many pounds of short-term assets the business has for each pound of short-term debt. In the illustration above it is £200,000 ÷ £150,000, or about 1.33.

The British Business Bank’s guidance says a ratio below 1 indicates a business is very likely to have difficulty meeting its short-term liabilities. Above 1, there is no single right answer: what is normal depends on your sector, how much stock you carry and how quickly customers pay.

A high ratio is not automatically good news either. It can mean cash is idle, stock is not selling or customers are being allowed to pay slowly. Some businesses also run with low or negative working capital on purpose, because they collect from customers before they have to pay suppliers. What matters is whether the position is planned.

Working capital is a snapshot of what the business holds and owes in the short term on one day, cash flow is the movement of money in and out over a period, and profit is income less costs over a period.

• Working capital shows the size of the cushion.
• Cash flow shows whether money arrives in time to pay each bill as it falls due.
• Profit shows whether the trade is worth doing at all.

You need all three. A business with positive working capital can still miss a payment if one large invoice is overdue in the week a tax bill lands. That is why a tax deadline belongs in the forecast as early as the sale that created it: our guide on how to pay a VAT bill explains when that money has to reach HMRC.

The working capital cycle is the time it takes to be paid after you have incurred the costs of delivering a product or service. The British Business Bank calls this the cash flow cycle, and makes the central point: the longer it is, the more capital the business needs.

Three things set the length of the cycle:

• Stock: how long materials and goods sit before they are sold.
• Debtor days: how long customers take to pay you.
• Creditor days: how long you have before you must pay suppliers.

Holding stock for longer or waiting longer for customers stretches the cycle. Longer supplier terms shorten it. A staffing firm shows the pattern clearly: it pays its workers every week and waits for its clients to settle on their own terms, which is why recruitment agencies so often fund the gap against their invoices.

Growth makes the gap bigger, not smaller. Every new order means more stock or wages paid before the customer pays, so a fast-growing business can run out of cash while its sales are rising.

If another business pays you late for goods or a service, you can charge statutory interest of 8% plus the Bank of England base rate, and claim a fixed sum towards the cost of recovering the debt. You cannot claim statutory interest if your contract sets a different rate of interest.

GOV.UK sets out when a payment counts as late. If you agree a payment date, it must usually be within 30 days for public authorities or 60 days for business transactions. If no date is agreed, payment is late 30 days after the customer gets the invoice, or 30 days after the goods or service are delivered if that is later.

The fixed sum can be charged once for each late payment, and you can also claim reasonable recovery costs above it. The government says late payment costs the UK economy £11bn a year and shuts down 38 businesses every day.

A change has been proposed but is not yet law. The Commercial Payments Bill was introduced in the House of Lords on 19 May 2026. As of October 2026 it has completed its Lords stages and is before the House of Commons, so the rules described above remain the law today.

The measures the government announced with the Bill include:

• A 60-day cap on payment terms for large firms paying smaller suppliers
• Mandatory interest on late payments at 8% above the Bank of England base rate
• Powers for the Small Business Commissioner to investigate, adjudicate disputes and issue fines
• A ban on retention clauses in construction contracts
• Reporting duties for large companies that persistently pay late

You improve working capital without borrowing by shortening the cycle: getting paid sooner, holding less stock and using the supplier terms you have agreed. None of these costs interest, so they come before finance.

• Invoice as soon as the work is done, and chase on the day a payment becomes overdue.
• Put clear payment terms in your contracts and on your invoices.
• Review stock lines that are not selling, and order closer to demand.
• Ask suppliers for terms that match how your customers pay you.
• Keep a rolling cash-flow forecast that includes VAT, payroll and loan repayments.

These steps deal with the cause. If customers always pay slowly, or the business model needs stock paid for months ahead of sales, the gap is structural and a one-off fix will not close it.

Businesses fund a working capital gap with finance that matches the cause of the gap: invoice finance for slow-paying customers, a revolving credit facility for gaps that come and go, and a loan for a defined one-off need.

All of these cost interest or fees, and all are subject to status and the lender’s criteria. Some are secured on business assets, and a lender may ask a director for a personal guarantee. Finance that covers a timing gap in a sound business is one thing. Finance that covers losses only postpones them.

Different providers specialise in different products, which you can see in our directory of business lenders. Before accepting an offer, read how to compare lender offers on total cost and not only the headline rate.

Capzy is a credit broker, not a lender, and is paid by the lender. We introduce businesses to lenders that offer working capital finance and set out what comes back so you can compare it.

You can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria. We do not give accounting or tax advice, so ask your accountant to check the figures behind any decision to borrow.