How Working Capital and Cash Flow Differ
If you have ever run a business, you likely have heard the terms working capital and cash flow. These are regularly used to describe the real financial health (as opposed to finances on paper) of a business. However, a lot of people have only a loose understanding of each. They may not realize how they differ. The more you understand business finance, the better off you will be.
This is the difference between your current assets and your current liabilities. Typically, an asset is considered current if it can be easily converted to cash. A liability is current if it will be due in the next 12 months.
When you examine your balance sheet, you don’t want to just have more assets than liabilities, you also want to make sure you are in the black currently as well. After all, if you owe a lot of money and can’t cover it, owning lots of capital assets won’t help much.
Cash flow is the amount of cash coming into your hands and leaving. Whereas your current assets and liabilities appear on your balance sheet, your cash flow is closer to your income statement. However, unlike income, it is only focused on cash. Accounts receivable aren’t cash.
For many businesses, the main difference is that your capital is viewed as a snapshot whereas your cash flow is viewed as a change over time. However, the difference can also be in how you handle certain transactions.
Which Do You Need?
The short answer is that both are important. They each describe a different part of your business’s financial health.
Comparing your current liabilities and assets will help you to understand whether your business is currently well-positioned to handle its financial obligations in the near future. It is a great snapshot of the more practical part of your balance sheet (long-term assets and liabilities matter also but are less immediate).
Your cash flow is a measure of whether you are bringing in enough cash. If you have negative cash flow, you can expect that your balance sheet will start to look worse very soon. However, it is looking into the past. You can project your cash flow, but that is just an estimation. Using both statements will help you to run your business better.
When you understand your business finances better, you can run a stronger business. Learn more today.