What is Working Capital and Why is it Critical for Business?

What is working capital? Definition and formula

Working Capital  measures a company’s operational liquidity: it is the difference between current assets and current liabilities. In simple terms, it is the cash available—or that can be generated in the short term—to cover immediate debts and expenses. Maintaining positive working capital ensures that the company can pay salaries, suppliers, and replenish inventory without financial strain. Conversely, low or negative working capital exposes the company to liquidity problems. This article reviews in detail what working capital is, its formula and utility, clarifies why it should not be confused with "fondo de maniobra" (in Spanish), and offers practical recommendations (with examples in industry, distribution, and services) to optimize it.

Working capital is calculated as the difference between a company's current assets and its current liabilities. In practice, this amounts to taking liquid cash, accounts receivable, and inventory, and subtracting short-term debts and accounts payable.

Its formula is:

Working Capital = Current Assets - Current Liabilities

For example, if a company has €200,000 in cash and inventory (current assets) and €100,000 in short-term debt (current liabilities), its working capital is €100,000. This amount indicates the "cushion" it has to operate on a day-to-day basis.

Working capital is, in essence, the “liquidity cushion” that guarantees operational continuity. With it, salaries, suppliers, and rent are paid, collection delays are managed, and production processes are sustained. Having sufficient current resources allows for covering daily debts and expenses without compromising activity. Healthy working capital avoids hasty decisions (such as taking on debt quickly or paralyzing operations) when collection delays arise or costs increase.

Importance of working capital

The state of working capital reflects short-term financial health. A company with adequate liquidity can grow sustainably. If working capital is insufficient, even profitable businesses can run out of liquidity to cover current expenses, which could lead to financial distress. Conversely, excessive working capital may indicate that the company is inefficiently accumulating inventory or customer balances.

In medium and large family-owned businesses, careful management of working capital is especially key. For many of them, the priority is long-term stability and business continuity. An adequate level of working capital allows for meeting obligations to suppliers and employees without forgoing strategic investments. In short, optimizing working capital is as important as improving margins: it is the key to generating sustainable value and protecting the company against crises.

Working capital vs. "fondo de maniobra":

In Spain, there is some terminological confusion between working capital and "fondo de maniobra". Although they are often used as synonyms, it is worth clarifying that they are not always exactly the same. Working capital is usually understood, in line with Anglo-Saxon literature, as operating working capital (current assets minus current liabilities) used by the company in its daily activity. On the other hand, fondo de maniobra is a traditional accounting concept in Spain that can be approached in different ways: from an asset perspective, it is also the surplus of current assets financed by long-term liabilities; and from a liability perspective, it is the remaining permanent resources after covering fixed assets.

A rigorous way to distinguish them is to speak of accounting working capital versus financial working capital. In company valuation, financial working capital excludes non-operating items: it does not include cash or short-term financial debt. In contrast, accounting working capital traditionally includes all current assets and liabilities.

The accounting fondo de maniobra may show the total surplus of current assets, while financial working capital focuses on the net working capital linked to operations (for example, excluding short-term bank debt). The confusion is such that many analysts use both terms without differentiation.

Sector examples

Different business sectors have peculiarities in their working capital. Below are three representative cases:

• Manufacturing industry. In manufacturing, inventory is usually the most significant item in current assets. An excessive volume of stock ties up liquidity. Therefore, optimizing inventory is key. For example, many factories apply Just-In-Time (JIT) systems to reduce average stock and free up cash. If demand is well-anticipated and suppliers respond quickly, a smaller inventory level can be maintained. Conversely, if there is overstock, the company suffers liquidity strain. Another typical factor is supplier financing: if the manufacturer secures long payment terms, it can finance part of the inventory through spontaneous financing, reducing the need for its own capital.
• Distribution and retail. Large retailers often show negative working capital, yet they do not lack liquidity. This is because they collect cash immediately from customers and negotiate long payment terms with their suppliers. Current assets (cash + inventory) may be lower than current liabilities (accounts payable). However, by having abundant cash or fast-rotating inventory, they do not suffer from a lack of liquidity. In terms of working capital, a typical distributor increases its liquidity by maintaining controlled stock and negotiating interest-free financing from suppliers. If inventory or accounts receivable increase, working capital grows (subtracting available cash), whereas increasing accounts payable decreases it (releasing cash).
• Service sector. In service companies (consultancies, law firms, etc.), the essential component of current assets is usually cash and accounts receivable. There is no physical inventory tying up capital, but there is credit extended to customers. Therefore, their working capital depends largely on the efficiency of invoice collection. Strict collection policies and early payment discounts can accelerate cash inflow. In contrast, current liabilities are usually low (no large inventories or intensive credit purchases). If a client takes a long time to pay, the service company’s liquidity may be compromised. This is why controlling accounts receivable is crucial. In this sector, digitalization and the use of electronic invoicing also facilitate collection tracking, improving working capital.

How to optimize working capital

Managing working capital efficiently is fundamental to releasing liquidity. Below are several practical recommendations:

• Inventory control. Reducing excessive inventory releases resources. Adopting lean production models (JIT) or improving demand forecasting helps avoid tying up capital in unnecessary stock. It is also useful to rotate slow-moving products (e.g., through promotions) and reduce procurement times (more frequent purchases in smaller batches). Real-time visibility of stock levels through ERP systems prevents over-purchasing.
• Management of accounts receivable. Accelerating invoice collection improves working capital. Measures include establishing rigorous credit policies (evaluating client solvency), offering early payment discounts, and invoicing immediately after service or product delivery. Additionally, regular monitoring of the Aging of Accounts Receivablehelps detect non-payments in time. The goal is to collect for products sold as diligently as possible. Some companies use factoring or confirming (reverse factoring) to convert receivables into immediate liquidity, improving their cash position.
• Negotiation of accounts payable. Extending payment terms to suppliers is a form of spontaneous financing. However, this is not about delaying payments without a strategy, but about negotiating conditions that align with the company's cash cycle. It is advisable to analyze each supplier's conditions and take advantage of early payment discounts only if they are beneficial. In general, the longer the Days Payable Outstanding (DPO), the more optimized the working capital will be. This must be balanced with maintaining good relationships: excessive delays can damage reputation and future supply.
• Adequate financing. When the business requires additional capital, it is helpful to differentiate between short-term and long-term debt. Renegotiating short-term debt for long-term financing can improve working capital (by reducing current liabilities) and alleviate liquidity burdens. Tools such as credit lines, policies, or bridge loans facilitate access to liquidity as needed. However, all external financing must be weighed against its costs to avoid sacrificing future profitability.
• Use of technology and management systems. Implementing digital systems (ERP, treasury software, resource planning solutions) provides real-time visibility of cash, collections, payments, and inventory. This timely information allows for quick decision-making: for example, rapidly detecting inventory discrepancies or overdue credits. Technology also automates processes (bank reconciliation, electronic invoicing), freeing up time and reducing errors. More professional management (and in many cases external, such as using logistics or administrative outsourcing) allows for focusing resources on the core business, optimizing the capital needed to operate.
• Corporate culture and continuous monitoring. Emphasizing internally that working capital is the responsibility of the entire company helps in its control. For example, encouraging the sales team to understand how their credit terms affect liquidity, or the purchasing area to coordinate with finance on payment terms. Establishing Key Performance Indicators (KPIs)—such as Days Inventory Outstanding (DIO) or Days Sales Outstanding (DSO)—and monitoring them periodically is essential. This ensures that improvements are sustainable over time.

Conclusion

Working capital is not an accounting concept: it is the thermometer of your business's operational health. Managing it well allows for reducing treasury strain and releasing cash to grow without continually depending on external financing. In an environment where costs and deadlines change rapidly, improving working capital can be one of the most effective levers to protect margins and gain room for maneuver.

If you want to analyze your working capital with rigor—identifying “cash leaks,” optimizing collections and payments, sizing inventory, and turning working capital into a competitive advantage—at Maraz Corporate Finance, we help companies and shareholders do so with a financial and practical focus: from diagnosis and improvement plans to monitoring with metrics (DSO, DPO, DIO) and support in working capital financing when it makes sense. Because improving working capital is not just about organizing numbers: it is about strengthening the company from within.

Javier de Rojas Roca de Togores

Partner - Maraz Corporate Finance