Cash Flow and Working Capital

This lesson covers AQA A-Level Business topic 3.5.2 — analysing financial performance through the management of cash flow and working capital. You will learn about the cash flow cycle, the role of receivables and payables, and the principles of working capital management.

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The Cash Flow Cycle

Key Definition: The cash flow cycle (also called the cash conversion cycle or working capital cycle) is the length of time between a business paying for its raw materials and receiving cash from the sale of the finished product.

The shorter the cash flow cycle, the less time the business's cash is tied up, and the less external finance it needs.

Stages of the Cash Flow Cycle

1. Purchase raw materials — cash outflow (or creation of a trade payable).
2. Production — raw materials are converted into finished goods (cash is tied up in work-in-progress and finished goods inventory).
3. Sale — goods are sold (but if sold on credit, cash is not received immediately — a trade receivable is created).
4. Cash received — the customer pays, completing the cycle.

Formula: Cash flow cycle (days) = Inventory days + Receivable days - Payable days

Worked Example: Cash Flow Cycle

Component	Days
Average time goods are held in inventory	45 days
Average time customers take to pay (receivable days)	30 days
Average time the business takes to pay suppliers (payable days)	40 days

Cash flow cycle = 45 + 30 - 40 = 35 days

This means that, on average, 35 days elapse between the business paying for its inputs and receiving cash from its customers.

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Trade Receivables and Trade Payables

Trade Receivables (Debtors)

Key Definition: Trade receivables are amounts owed to the business by customers who have purchased goods or services on credit but have not yet paid.

• Receivables represent cash the business is owed but has not yet received.
• The longer customers take to pay, the worse the business's cash flow position.
• The receivable days ratio measures the average number of days it takes to collect payment.

Formula: Receivable days = (Trade receivables / Revenue) x 365

Worked Example

If trade receivables are £60,000 and annual revenue is £720,000:

Receivable days = (60,000 / 720,000) x 365 = 30.4 days

This means, on average, customers take just over 30 days to pay.

Trade Payables (Creditors)

Key Definition: Trade payables are amounts the business owes to its suppliers for goods or services purchased on credit but not yet paid for.

• Payables represent a source of short-term finance — the business has the goods but has not yet paid for them.
• The payable days ratio measures the average number of days the business takes to pay its suppliers.

Formula: Payable days = (Trade payables / Cost of sales) x 365

Worked Example

If trade payables are £40,000 and annual cost of sales is £480,000:

Payable days = (40,000 / 480,000) x 365 = 30.4 days

This means, on average, the business takes just over 30 days to pay its suppliers.

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Working Capital

Key Definition: Working capital is the capital available to fund the day-to-day operations of a business. It is calculated as current assets minus current liabilities.

Formula: Working capital = Current assets - Current liabilities

Current Assets	Current Liabilities
Cash and bank balances	Trade payables
Trade receivables	Short-term borrowings (overdraft)
Inventory (stock)	Tax owed
Prepayments	Accruals

Why Working Capital Matters

A business needs sufficient working capital to:

• Pay suppliers on time (maintaining good relationships and credit terms).
• Pay wages and salaries.
• Cover day-to-day operating expenses (rent, utilities, etc.).
• Hold adequate inventory to meet customer demand.

Too little working capital means the business may be unable to meet its short-term obligations — it risks insolvency.