Working Capital Strategies That Work for start-ups, SME's and MSMEs

One of the most critical aspects of running a business - beyond having a great idea, product, or operations - is capital, or simply put, money. In the case of startups, founders typically begin with their own funds, a practice commonly known as bootstrapping. As the business gains traction, it may seek external funding through bank loans, financial institutions, or investors.

While initial capital is essential to set up operations and launch the business, long-term sustainability and growth depend heavily on the ability to generate cash from operations. This is where working capital plays a vital role.

What is working capital

Put simply, working capital is the ongoing liquidity a business needs to run its day-to-day operations.

In other words, working capital refers to the funds a business needs to manage its day-to-day operational activities, such as paying suppliers, employees, and managing inventory and receivables.

A healthy working capital position reflects the fact that a business has enough short-term resources to meet its short-term obligations. On the other hand, poor working capital management indicates that the business may struggle to fulfill even its immediate financial commitments, potentially affecting operations and credibility.

Working capital is defined by the formula:

Working Capital = Current Assets - Current Liabilities

Current assets typically include inventory, trade receivables (debtors), cash and bank balances, and short-term loans and advances.

Current liabilities include payables to vendors (creditors), short-term borrowings or bank overdrafts, salaries and wages payable, and other outstanding expenses.

Why Working Capital Matters More Than Profitability

1. Profit Is on Paper, Cash Is Reality

As we all know, the profit or loss shown in the Profit & Loss Account does not always reflect the actual cash generated by the business. In many cases, a business may show a profit on paper but still struggle with cash flow. This often happens because the receivables due from customers are significantly higher than the payables owed to vendors for raw materials, inventory, and other inputs.

Profit is an accounting concept, but cash is reality. Efficient working capital bridges these gaps and keeps operations steady.

2. Liquidity Keeps the Business Running

A business can survive without profit for some time - especially during growth or early stages - but it cannot survive without liquidity. In the early days, many expenses - such as salaries and operational costs - require immediate cash outflow. Lack of working capital is one of the top reasons startups fail.

3. Growth Needs Capital

Even a growing business consumes more cash: more inventory, more manpower, more receivables. Without managing working capital well, growth itself can create a cash crunch.

4. Poor Working Capital Can Kill Profit

If you're forced to borrow at high interest or delay payments (damaging relationships), your profits erode quickly. Good working capital management protects your margins.

5. Investor & Lender Confidence

Investors and banks look not just at your P&L, but your ability to manage cash responsibly. Strong working capital signals financial discipline

At the same time, many expenses - such as salaries and operational costs - require immediate cash outflow. Additionally, substantial funds are often tied up in inventory and its associated carrying costs. This creates a gap between the inflow and outflow of funds, which must be managed carefully to ensure smooth day-to-day operations.

That's why working capital management becomes critical - often more important than profitability. Because without adequate liquidity, even a profitable business can run into trouble

Key Levers of Working Capital Management

How to Monitor and Improve Working Capital

Designing a strong working capital strategy is essential - but equally important is consistently monitoring and reviewing it.

Key Steps to Monitor and Improve Working Capital:

1. Track Key Metrics Regularly:

Use financial ratios and indicators to evaluate working capital health:

• Current Ratio
• Quick Ratio
• Days Sales Outstanding (DSO)
• Days Payable Outstanding (DPO)
• Inventory Days

These ratios give insights into the efficiency of receivables, inventory, and payables.

2. Include Working Capital Review in Monthly Financials:

As part of the monthly MIS or financial review decks, include:

• A working capital summary
• Slides showing trends in DSO, DPO, inventory days, and cash conversion cycle
• Commentary on key changes and action points

3. Use Dashboards and Visual Tools:

Build real-time dashboards using tools like Excel, Power BI, or Zoho.

• Visualise the movement of working capital levers.
• Highlight areas needing immediate attention.

4. Establish Strong Internal Controls:

• Set limits, approval workflows, and escalation mechanisms.
• Conduct periodic reviews with functional heads (sales, procurement, operations).

5. Create Accountability:

• Assign KPIs related to receivables, inventory, and payables to respective teams.
• Link incentives where feasible to working capital efficiency.

Common Working Capital Mistakes

1. Over-reliance on credit sales

In many businesses, especially growing ones, the focus tends to be on increasing top line (revenue) rather than bottom line (profit). While chasing revenue, there's often a tendency to push sales through extended credit terms just to show growth.

However, this short-term gain can lead to long-term pain:

• Delayed payments stretch the receivables cycle.
• Cash flow tightens, affecting day-to-day operations.
• Bad debts may rise if customers default or delay too much.
• It increases working capital requirements, putting pressure on external funding or reserves.

2. Ignoring receivables aging & poor collections

While offering credit may be necessary to remain competitive, it's critical to establish discipline and controls around collections. Efficient receivables management directly improves working capital and ensures smoother cash flow. Processes like reviewing ageing regularly, monitoring continuously, using automated tools for follow ups etc. crucial. Delayed invoicing can also be some time reason for delayed collections.

3. Overstocking inventory

Inventory is essential to run operations, but excess inventory locks up cash and increases carrying costs (like storage, insurance, damage, and obsolescence). On the other hand, stock-outs lead to missed sales and customer dissatisfaction. Therefore, the goal is to strike a balance between availability and efficiency.

4. Avoiding the trap of funding operations from equity

One of the most common yet critical mistakes many founders make is using equity funding to cover day-to-day operational expenses or working capital requirements. While it may seem convenient in the short term, this practice can be detrimental to long-term growth and scalability.

Equity capital is meant to fuel growth - for investments in product development, technology, market expansion, and talent acquisition - not to patch cash flow gaps or recurring operational costs. Using equity for daily operations dilutes ownership unnecessarily and weakens the return on investment for both founders and investors.

Instead, businesses should aim to:

• Improve internal cash flow through better receivable management and inventory optimization.
• Leverage working capital financing (e.g., short-term loans, invoice discounting, trade credit)
• Establish disciplined cash flow planning to forecast and avoid shortfalls

By separating growth capital from working capital, founders can build a more sustainable, capital-efficient business that attracts better-quality investors in future rounds.

5. Not Having a System for Cash Flow Forecasting

One of the key gaps in many businesses is the absence of a structured cash flow forecasting process. Without visibility into expected inflows and outflows, it's difficult to plan payments, manage receivables, or ensure smooth operations.

A weekly or monthly cash flow forecast helps:

• Predict cash shortages or surpluses in advance
• Plan vendor payments, tax outflows, and salary disbursements more effectively
• Avoid last-minute borrowing or delayed payments
• Support better working capital planning

Best practice is to integrate forecasting with your accounting or ERP system and update it regularly based on actuals. This not only builds financial discipline but also supports better decision-making and stakeholder confidence.

Conclusion

In today's dynamic business environment - where margins are shrinking, competition is intensifying, and technology is constantly disrupting traditional models - liquidity has become one of the most critical factors for business survival.

Profitability alone is not enough. Businesses must ensure that cash is available when needed to fund operations, pay vendors, meet payroll, and invest in growth. This is only possible through disciplined and proactive working capital management.

Ultimately, liquidity is the fuel that keeps the business engine running - and working capital is the key to maintaining that fuel consistently.