Insufficient liquidity is one of the greatest risks to day-to-day operations. A company that is unable to fulfil its regular commitments risks financial difficulty and a reduced ability to act. As such, the stability and growth of a business rest fundamentally on managing its available resources with foresight. An important metric in this context is working capital.

In this article, you’ll learn what working capital is, how to calculate it, what causes low or negative working capital, and how to increase it. We’ll also shed some more light on steps you can take in-house, as well as factoring and working capital financing options.

Key takeaways

• Working capital indicates whether a business is able to fulfil its regular commitments, and how stable its liquidity is.
  
• When a business has negative working capital, that means its current liabilities are higher than its current assets.
  
• The primary causes of negative working capital include long payment terms, high inventory levels, and rising costs.
  
• Businesses can improve their working capital by enhancing payment terms, reducing inventory, and managing costs efficiently.
  
• Financial instruments such as factoring, working capital loans, or revenue-based models can help to shore up liquidity and finance growth.
  

What is working capital?

Working capital is a key operational metric, describing a business’s net current assets. It shows which financial resources are on hand for regular operations and whether the business can meet its commitments, including salaries, rent, and payments to suppliers. At the same time, working capital shows whether there is any budgetary room for growth and investments.

Working capital is, therefore, an indicator of your short-term financial stability. Businesses use it to evaluate their solvency. Business partners and investors also use this metric to assess risks and a business’s overall finances.

Calculating working capital

Calculate working capital by subtracting current liabilities from current assets. Current assets include all resources readily accessible to a business, in particular cash and cash equivalents, inventories, and trade receivables. Short-term liabilities primarily comprise open invoices for supplies and services procured, as well as borrowings.

Working capital is the difference between a business’s current assets and its current liabilities. Positive working capital means that there are sufficient funds available to cover existing commitments. Negative working capital is often a warning sign: it indicates that obligations exceed short-term assets and that liquidity bottlenecks could be on the horizon.

Causes of low or negative working capital

Low or negative working capital indicates that your available funds are insufficient to cover your existing obligations. There are lots of different causes, and low or negative capital is usually caused by a combination of factors:

• Long payment terms for customers: Businesses often grant their customers generous payment terms, so it takes them longer to get paid.
  
• Short payment terms from suppliers: Long payment terms for customers can become particularly problematic if you have to settle your own liabilities quickly.
  
• High volume of outstanding receivables: When invoices remain unpaid for an extended period, the business cannot use that capital to support its day-to-day operations.
  
• Inadequate accounts receivable (AR) management: Poor oversight of due dates and collection efforts can result in overdue invoices or unpaid balances.
  
• Large inventories: High inventory levels tie up financial resources, as goods are purchased and warehoused before they generate any revenue.
  
• Rising costs, stagnant earnings: If costs for things such as energy, staff, or purchases rise, the liquidity available in your current assets falls.
  
• Seasonal fluctuations: In certain industries, fluctuations in revenue over the course of the year mean that sometimes nothing is coming in, while regular costs still have to be paid.
  
• Reliance on external financing: If you finance some of your operations through short-term loans, this increases your current liabilities and puts a strain on your working capital.
  
• Tax bills: Tax payables can significantly reduce liquidity, as they often have to be settled in large amounts at fixed times.
  
• Prefinancing value-added tax (VAT): Businesses must prefinance VAT when purchasing goods and services, tying up capital until they settle with the tax office.
  

How can businesses in Germany increase their working capital?

Businesses can improve their working capital by targeting specific areas of their operations for action. Below are some of the most common steps to consider:

• Adjust payment terms
  Businesses need to use their negotiating position to achieve a better balance in their payment flows. Shorter customer terms and longer supplier terms give you greater control over cash flow, and allow for achieving a better ratio of incomings to outgoings. Early payment discounts and other incentives can also have a positive impact.

• Reduce inventory
  Efficient inventory management reduces tied-up funds in your current assets. First, inventory itself ties up cash because goods need funding and storage before customers purchase them. Second, VAT on purchases impacts liquidity, as input tax must be prefinanced and is released later through your tax return. Businesses can enhance their inventories with better planning, forecasting, and harmonised supply chains. The goal is to avoid overstocking while maintaining deliverability.

• Manage costs and increase efficiency
  Managing and reducing regular expenses directly improves working capital. Businesses can identify potential savings and simplify their processes. A better cost structure increases the resources available for your business’s operations and consolidates your long-term financial stability.

• Factor in seasonal effects
  Businesses need to account for seasonal fluctuations in their liquidity planning. Planning with foresight makes it easier to ride out periods of lower earnings. Reserves or flexible cost structures can help offset fluctuations, keeping your working capital stable when revenue is low.

Other ways to improve this metric include enhancing AR management and taking more concrete steps, such as working capital financing

Improving working capital through factoring

Efficient AR management is an effective way of improving your working capital. That’s because late or unpaid invoices tie up funds and weaken solvency. Businesses can counteract this by consistently monitoring their accounts and collecting receivables faster. Clear payment terms and structured dunning can help you get paid more quickly.

Factoring

An alternative to managing your AR internally is to use factoring. Under this arrangement, businesses sell their outstanding receivables to an external service provider, known as a factor, and receive the majority of the invoice amount immediately. That approach releases tied-up capital in less time. Depending on the specific contract, the factor might also be responsible for all AR management activities and assume default risk.

Factoring is particularly suitable for businesses that need liquidity fast, e.g., to cover regular expenses or planned investments. It’s also a good financing option if you have long payment terms with your customers, as it helps you plan your income. However, there are costs to consider when factoring.

Working capital financing options

In addition to factoring and in-house measures, German businesses can stabilise their working capital through appropriate financing, helping them bridge liquidity bottlenecks. There are a variety of options to match different needs and business models:

Working capital loans

Businesses in Germany can take out working capital loans from banks to finance their working capital short-term. Unlike long-term loans for investments, the focus here is on ensuring the business remains solvent day to day.

The relatively short loan terms reflect the need for short-term financing. Businesses typically repay working capital loans from ongoing income generated by day-to-day operations. They are mainly suited to filling temporary liquidity gaps. At the same time, they don’t impact your financial flexibility, as there is no long-term funding commitment.

Supplier credit

Supplier credit is a situation in which a business procures goods or services but does not pay for them until a later date. By agreeing on payment terms with their suppliers, they delay the actual outflow of capital. The business can use the goods or services before the invoice is due.

This type of financing is closely tied to the existing business relationship and typically does not require a separate application. That makes it relatively straightforward to implement and provides quick access to funds.

Revenue-based financing

With revenue-based financing, businesses obtain funding according to recent performance and repay it as a percentage of earnings instead of using fixed instalments. That means they pay back more during higher-earnings periods and less during lower-earning periods.

This flexible structure offers particular advantages for businesses with fluctuating revenue, enabling them to align income with outgoings better and reduce the risk of financial bottlenecks. At the same time, it gives them greater scope for planning, since there are no fixed repayment obligations.

How Stripe Capital can help you manage your working capital

Stripe Capital offers businesses in Germany revenue-based financing for their working capital. Funds are provided directly via the existing payments infrastructure, so there’s no need for lengthy application processes. Unlike traditional bank loans, it doesn’t require either substantial collateral or lengthy screening, giving businesses quick access to resources they can deploy immediately across their operations.

Stripe Capital is suitable for businesses that need liquidity fast, have fluctuating earnings, or want to grow. Financing is tied to your actual revenue, meaning it adapts to the ups and downs of your business.

FAQs

Below are answers to the most important questions about working capital.