How Much Working Capital Should a New Business Keep?

The difference between 'Profit' and 'Cash'

A business can be profitable on paper but still fail because it runs out of cash. Profit is what remains after all costs are deducted from sales; cash is the actual money you have in the bank to pay your bills today. If you have sold £10,000 worth of services but your customers have 30-day payment terms, you have £10,000 in profit but £0 in cash to pay this week's rent.

Working capital is the buffer that fills this gap. It allows you to continue trading while you wait for your invoices to be settled. Many new businesses fail not because they lacked customers, but because they couldn't manage the timing of their cash flows. Understanding this distinction is fundamental to survival.

Evans Founder Advisory (/founder-advisory) often works with new businesses to map these cash cycles and ensure they don't grow themselves into a liquidity crisis.

How to calculate your required working capital

To find your number, start by listing every recurring monthly cost: rent, software subscriptions, insurance, utilities, and a minimum salary for yourself. Then, add the variable costs required to deliver your service, such as materials or freelancer fees. This total is your monthly 'burn rate'.

A safe working capital reserve is usually 3 to 6 times this burn rate. If your monthly costs are £3,000, you should aim to keep between £9,000 and £18,000 in the bank at all times. This reserve is not there to be 'invested' in growth; it is there to ensure that a single late-paying client or an unexpected repair doesn't force you to stop trading.

Illustratively, if you have £15,000 in capital, you might spend £3,000 on launch and validation, and keep £12,000 as four months of working capital. Spending all £15,000 on a launch is a high-risk strategy that leaves no margin for error.

Protecting your 'Oxygen': Why cash reserves matter

Cash is the oxygen of a business. When you run out, the business stops immediately, regardless of how good the idea is. In the first year, your primary goal is not to maximise profit, but to maintain liquidity. This means being disciplined about what you spend and aggressive about collecting what you are owed.

Avoid the temptation to 'reinvest every penny' back into the business early on. Growth is important, but only if it is sustainable. Keeping a healthy cash reserve gives you the confidence to make better long-term decisions rather than desperate short-term ones. It also makes you more attractive to future partners or lenders who will look at your 'cash position' as a sign of professional management.

Managing the 'Cash Conversion Cycle'

The Cash Conversion Cycle (CCC) is the time it takes for a pound spent on the business to come back as a pound (plus profit) from a customer. In a service business, this is the time between starting work and receiving the final payment. In a product business, it includes the time stock sits in a warehouse.

Your goal is to keep this cycle as short as possible. You can do this by asking for upfront deposits, using shorter payment terms (e.g., 7 days instead of 30), and automating your invoicing process. Every day you shave off this cycle reduces the amount of working capital you need to hold in reserve.

Check official guidance from HMRC regarding VAT and tax payment dates, as these represent large, periodic outflows of cash that must be planned for well in advance to avoid a working capital shock.

Common working capital mistakes for new founders

The most common mistake is spending the working capital on 'fixed' assets like fancy office furniture, expensive equipment, or a custom-built website before the business has proven its model. Once cash is turned into a fixed asset, it is very difficult to turn it back into cash if you need to pay a bill.

Another mistake is 'over-trading' — taking on so much new work that the upfront costs (materials, staff) consume all your cash before the customers pay their invoices. Rapid growth can be just as dangerous as no growth if your working capital isn't managed correctly. Always ensure you have the cash to *deliver* the work before you sign the contract.