The importance of working capital in a start-up company


After completion of my MBA, I was associated with a start-up in the retail segment. The life span of the business was 10 months but there was so much I had learned from the failure such that I made a case study of the business. The company was suffering losses and was not able to recover the monthly losses which were stacking month-on-month. The main reason for the business to suffer losses was lack of working capital management.

What I understood from this company that there are basically 3 reasons that every start-up needs to understand the importance of working capital.

  • The distance to achieve the break even– The management kept a projection of 6 months to reach break even. Lack up funds for the working capital lead to the increase of the break even achievement. Even 25% of the break even was not achieved even after 9 months of operation. Management should make working capital as one of the pillar for the achievement of break even.
  • Working capital eats up revenue– The Company started generating revenue in the first month of business but was not able to match the expenses which lead to the operating losses for the business. The cost for generating a sale was much higher than the revenues earned from the goods. Cost management has to be made the driving force for working capital management.
  • Additional borrowing add more liabilities to the balance sheet– The management found that the external borrowing would add up more cost in running the business with additional interest rate. The management was worried about the additional burden of repayment of interest which added more risk of default to the creditors. Adding liquidity in the business by borrowing is more relevant than closing the business.

It is important for a start- up to create a budget for working capital for at least two quarters so that the management could understand the need for the funds required for working capital. Once the quarterly budget is fixed, the management should divide it into monthly budget and try to reach the cost below the previous month in order to earn operating profits by benchmarking. A strict control of cash flows controls the working capital which would help in maintaining the financial health of the company.

Any feedback from you is highly appreciable.

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