How to work out if you are “growing broke”?

If your business requires more working capital for each £1 revenue than it earns in gross margin, then you are going backwards in cash. What do we mean by this?

Say, for example, your working capital for the next £1 in revenue is 40% and the business produces 30% in gross margin for every £1 of revenue, then this means that for every £1 of sales, the business requires 10 pence more working capital than it actually produces in gross margin.

Let’s see how to calculate these ratios:

AR: Accounts Receivables    AP: Accounts Payable

The above shows the importance of understanding the relationship between working capital and profitability. If your business requires more working capital than it produces in gross margin, than you are not going to survive unless you make changes to either

1. Increase your gross margin or
2. Reduce your working capital

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