Working Capital: What It Is and Why It Matters for Canadian Small Business

Your working capital is the heartbeat of your business. It is the difference between being able to pay suppliers on time and having to delay an order. It’s also what decides whether one business can take on a new opportunity while another has to pass it by. 

Unfortunately, despite how important working capital is, about 18% of businesses in Canada report cash flow management challenges according to Payments Canada. These challenges can make it difficult for a business to cover day-to-day expenses like supplier payments, payroll, and even rent. And at the worst end of the spectrum, it can even lead to business closure if cash flow isn’t stabilized. 

Evidently, it’s important to better understand working capital. That’s why our team at Bizfund is answering today’s questions like ‘what is working capital,’ while looking at how to improve working capital, and the working capital ratio in Canada. These insights could be what makes or breaks your company. 

Working Capital Defined 

To put things very simply, working capital is the money your business has available to keep daily operations moving. A simple equation for this is: working capital = current assets minus current liabilities, according to Investopedia. 

Your business’s current assets include cash, accounts receivable, and inventory that can realistically be converted to cash within a calendar year. On the other hand, your current liabilities include short-term obligations like supplier invoices, loan payments, wages, HST/GST, and other taxes owed. 

So, what this means is that your working capital shows whether you have enough breathing room to cover what is coming due soon. If you have a healthy balance, you have flexibility, while a tight balance can make every decision, including paying staff, ordering inventory, or turning down work, feel much harder. 

The Working Capital Cycle for Canadian Businesses

Now that you have a better understanding of what working capital is, you should learn a little more about the working capital cycle for Canadian businesses. Despite what you might have already learned, working capital does, in fact, move in a cycle. 

For example, you use money to buy inventory or deliver services, which generate revenue. This revenue then returns cash to your business. The process is simple, but…the timing of each step shapes how much working capital your business needs.

In Canada, CRA remittances, supplier payment terms, delayed invoices, and seasonal revenue patterns can all affect the timing. This is why the cycle matters in day-to-day decision-making.

Working Capital Ratio – What’s Healthy by Industry?

The working capital ratio is continuously developing, so it’s important to remember this as a business owner. Although there is no known inventor, it stems from accounting and financial analysis practices from the late 19th and 20th centuries. It was created to help lenders and businesses assess liquidity. 

With that said, the working capital ratio compares what you have available to what you owe in the short term. Usually, a ratio above 1.0 generally indicates that the business can meet its near-term obligations. However, what is actually considered ‘healthy’ depends heavily on the industry in which you operate. 

The Low Down

Insights from Statistics Canada on financial performance by industry, along with guidance from the Business Development Bank of Canada on managing cash flow and liquidity, show that different sectors operate within distinct ranges. These ranges depend on inventory levels, payment cycles, and margin structures.

With that in mind, the table below reflects example working ranges. If you’re exploring and trying to understand working capital for a small business in Canada, you may want to check it out:

However, it’s important to keep in mind that these ranges should be read as directional. If your business falls slightly outside of these bands, it doesn’t mean you’re necessarily at risk. But if you notice a ratio that continues to trend downward, it’s usually worth reviewing. 

Signs Your Working Capital Is Under Pressure

Your working capital is unlikely to become an issue overnight, as you’ll start to notice patterns indicating it’s under pressure. A few of the signs can include: 

• Supplier payments start slipping: You might notice that your business is extending payment terms or prioritizing certain suppliers over others. Usually, this will happen without you quite realizing it, but it unfortunately signals that incoming cash isn’t keeping up with outgoing obligations. 
• Payroll feels tighter than expected: Even if your business plans carefully, there could be moments where payroll requires more planning than it should. When payroll feels harder to pay, it is usually because of timing gaps between receivables and expenses. 
• Inventory decisions become reactive: When you’re only purchasing inventory when cash is available and not with demand, it’s highly likely that your decisions are becoming reactive. This strongly indicates working capital issues, and it can even lead to missed sales or project delays. 
• Tax obligations feel like a surprise: When remittance season rolls in for taxes, and you don’t have the funds because you spent them on operations, this indicates working capital problems. This can create immense pressure when you don’t have the funds to pay your business’s taxes, leading to delayed payments, payment plans, and potential financing needs. 

If you can recognize these signs earlier, it can make it easier to adjust or course correct before the situation becomes restrictive. 

How to Improve Working Capital Without a Loan

Before you look into pricing, there are a few techniques you can explore to improve working capital. Here’s what we suggest you consider: 

1. Improve payment timing: It’s important to shorten the time it takes to get your business paid. So, it’s a good idea to review how quickly invoices are sent and followed up on. On this front, even small improvements in payment timing can have a noticeable impact on cash flow. 
2. Adjust supplier terms: If possible, it’s worth adjusting supplier terms to better align outgoing payments with incoming cash. If you want to explore this option, try to do so with consistent or long-standing clients. 
3. Review inventory levels: Unfortunately, holding too much inventory ties up your money, but holding too little can disrupt sales. We know it can be difficult, but it’s uber important to find the right balance to help keep money available without affecting your operations.

When External Financing Makes Sense 

There are times when you need a little extra assistance, especially when internal adjustments to help navigate the working capital you have just aren’t enough. This is why you should consider external financing. 

You can use external financing to help alleviate some of the financial pressure you might be experiencing with seasonal demand, supply chain issues, growth, or longer payment cycles that are creating gaps. However, the trick to applying for external financing is knowing when it will support your business and when it will just add further strain. 

For example, let’s imagine you’re a contractor who is waiting on progress payments. If these payments aren’t coming in fast enough, you could use short-term funding like a merchant cash advance to keep projects moving. 

Or let’s think of you as a retailer who is preparing for a busy season. In this situation, you might consider securing funding in advance to purchase the inventory you will need in the future. Regardless of the type of business you operate, every funding situation will be different, so there isn’t a one-size-fits-all solution. You need to assess your working capital needs and explore appropriate business financing options. 

The Wrap-Up On What to Know about Working Capital for a Small Business In Canada

Working capital sits at the centre of how a business runs day to day. It affects decisions that seem operational but are often financial at their core. When it is managed well, the business has room to operate and grow. However, when it isn’t, even routine decisions can feel more difficult than they should. 
So, taking the time to understand how working capital moves through your business can make it easier to plan ahead, avoid pressure points, and support the next stage of growth. If you want to learn more about your options or need access to fast funding, you can very easily apply for a merchant cash advance today with us at Bizfund. We offer a quick, easy funding application process, and you could qualify for up to $300,000, with funds disbursed within 24 to 72 hours.