Working Capital, Explained Like a Wholesaler Profitable, Yet Broke

Stock, unpaid invoices and supplier bills decide whether a profitable business has cash on the 5th. An illustrative wholesaler shows how.

A wholesale trader looks at her books at the end of the month. Sales are good. The accounts say she made a profit. Yet on the 5th, when wages and rent are due, her bank balance is almost empty.

Nothing is wrong with her maths. The problem is timing. Her profit is real, but it is not in her account yet. It is sitting on shelves and in other people's promises.

This is the idea of working capital. It is one of the most useful ideas in business, and it explains why healthy-looking companies fail. I'll explain it with an illustrative trader. The numbers are made up to show the logic.

What working capital means

Working capital is the money your business needs to run day to day. In books, it is the short-term things you own (cash, stock, money customers owe you) minus the short-term things you owe (bills due soon).

Three parts matter most:

• Receivables. Money customers owe you for goods already delivered.
• Stock. Goods you have paid for but not yet sold.
• Payables. Money you owe your suppliers.

A trader who buys goods, stores them, sells them on credit and waits to be paid has to fund every step in between. That gap is the working capital she must find from somewhere.

An illustrative trader

Say she sells about $100,000 of goods a month. The goods cost her $85,000. After wages, rent and other costs, she keeps about $5,000 a month as profit. These numbers are illustrative.

Now look at her timing.

• Goods sit in her warehouse for about 30 days before they sell.
• Her shop customers take about 45 days to pay.
• Her suppliers want to be paid in about 15 days.

Her cash gap is stock days plus customer days, minus supplier days. That is 30 + 45 − 15 = 60 days. For 60 days, her own money is out there, funding her customers.

What that gap costs

If she buys about $85,000 of goods a month, then two months of buying is roughly $170,000. That much cash is tied up in stock and unpaid invoices at any one time. The profit on top of that is $5,000 a month.

So she needs a large pool of cash just to keep the shelves full and the trucks running. If she doesn't have it, she borrows, or she delays paying wages. Either way, a "profitable" business feels broke.

Why growth makes it worse

Say sales double. Profit on paper doubles to $10,000. But the money tied up also doubles, to about $340,000. She has to find another $170,000 before the new profit ever arrives.

This is a common way for good businesses to get into trouble. Orders flood in. Every order needs stock bought now and payment collected later. The business runs out of cash while it is winning.

Credit terms are the real decision

Now the useful part. The gap is not fixed. It comes from three choices she makes, mostly without noticing.

Customer terms. Ask customers to pay in 30 days instead of 45. That cuts the gap by 15 days. A small discount for paying early might be cheaper than borrowing money to wait.

Stock. Keep fewer slow items. Goods that sit for 90 days are cash asleep on a shelf.

Supplier terms. Ask suppliers for 30 days instead of 15. Good relationships and steady orders can earn this.

Change all three a little and her 60-day gap can shrink to about 30. In the illustrative sum, that frees roughly $85,000. That is cash she didn't need to borrow.

A caution

These are simple sums. Real businesses have seasonal swings, late payers and suppliers who change terms. Squeezing customers too hard can lose them. Paying suppliers late can hurt trust. Treat these as levers to adjust carefully, not tricks.

Warning signs

You may be running short of working capital when:

• profit looks fine, but the bank balance keeps falling;
• you delay supplier payments to pay wages;
• you say yes to a big order and feel worried, not happy;
• you borrow every few months to cover the same gap.

Any one of these can have other causes, so use them as a prompt to check your three numbers, not as a diagnosis.

A useful habit is to look at cash weekly, not only profit monthly. A simple list of money coming in and going out over the next eight weeks will show a squeeze long before it arrives.

Try this week

Find three numbers: how many days your stock sits, how many days customers take to pay, and how many days you take to pay suppliers. Add the first two, subtract the third. That is your cash gap. Then pick one number to improve by a few days.

What I take from this

Profit tells me if the business works. Cash timing tells me if it survives. I want to look at both before I say yes to a big order.

Sources

• In-house explanation. All numbers in this article are illustrative.
• Working capital, receivables, payables and stock are used in their standard accounting meaning.