Ask a business owner how much funding they need and you will usually get a round number. Fifty thousand. A hundred. Twenty-five to be safe. The number is almost never wrong because the owner is careless — it is wrong because nobody ever showed them the calculation that produces a right one.
That matters more than it sounds. Borrow too little and you are back at the bank in seven months, from a weaker position, having already used the easy option. Borrow too much and you are paying interest on money sitting in an account doing nothing. Borrow the right amount in the wrong shape — a three-year term loan for a problem that recurs every quarter — and the repayments become the new cash-flow problem.
There is a proper answer, and it comes out of numbers you already have.
The thing you are actually funding
Start by being precise about what the money is for, because there are only really three kinds of funding need and they want different products.
The first is an asset: a van, a machine, a fit-out. It is a one-off, it has a life of several years, and the funding should be repaid over roughly that life. The second is a step change: buying a business, opening a second site, a genuine one-off project. Again, one-off, and a term loan matched to how long it takes to pay back.
The third is the one that catches everyone, because it does not feel like a funding need at all. It is the cash permanently tied up in simply operating — stock sitting on shelves, invoices issued but not yet paid, less whatever your own suppliers are letting you owe them. That is your working capital gap, and it is not a one-off. It is a permanent feature of your business, it grows when you grow, and it never comes back until you shrink or close.
The working capital gap is the money your business has already spent that it has not yet been paid for. It is not a temporary shortfall. It is the cost of being open.
Working out your gap in twenty minutes
You need three figures from your last set of accounts or your bookkeeping system: trade debtors, stock, and trade creditors, all at the same date. Then:
Working capital requirement = trade debtors + stock − trade creditors.
That is the number. It is how much of your own cash is permanently committed to running at your current size. To understand where it is coming from, convert each part into days:
Debtor days = (trade debtors ÷ annual sales) × 365. Stock days = (stock ÷ annual cost of sales) × 365. Creditor days = (trade creditors ÷ annual cost of sales) × 365. Add debtor days to stock days, subtract creditor days, and you have your cash conversion cycle: the number of days between paying for something and being paid for it.
A worked example
Take an illustrative wholesaler turning over £600,000 a year, with cost of sales of £360,000 — a 40% gross margin. At the year end its balance sheet shows trade debtors of £82,000, stock of £45,000 and trade creditors of £34,000.
The working capital requirement is £82,000 + £45,000 − £34,000 = £93,000. That is how much cash the business has locked into simply operating at £600,000 of sales.
In days: debtors are (82,000 ÷ 600,000) × 365 = 50 days. Stock is (45,000 ÷ 360,000) × 365 = 46 days. Creditors are (34,000 ÷ 360,000) × 365 = 34 days. So the cycle is 50 + 46 − 34 = 62 days. The business pays for goods and waits just over two months to see that money again.
Now the part that decides the funding conversation. Suppose the owner wins a contract that grows sales 30%, to £780,000, and everything else scales with it. The working capital requirement becomes £93,000 × 1.3 = £120,900. The business needs an extra £27,900 of cash purely to operate at the larger size. Not for equipment. Not for marketing. Just to stand still, bigger.
That growth also generates gross profit — 30% more sales at a 40% margin is £72,000 of extra gross profit over the year. But that arrives in dribs over twelve months and after overheads, while the £27,900 is needed in the first few weeks, up front, as stock is bought and invoices go out. That mismatch is the single most common reason a growing, profitable business runs out of money. It is the same mechanism explained in cash flow vs profit, with a number attached.
Size the facility on the peak, not the average
One refinement, and it is the one most owners miss. The calculation above uses a year-end snapshot. If your business is seasonal, the year end may be your quietest point — the moment stock is lowest and debtors are thinnest.
Run the same three figures at your busiest month instead. A garden centre in February and the same garden centre in May are two different businesses on the balance sheet. Fund the May version. A facility sized on the average leaves you short at exactly the point in the year when being short costs you the most, because that is when you cannot buy the stock that makes the season.
Match the money to the shape of the need
Once you know the number, the product almost picks itself.
A gap driven mostly by debtor days points at invoice finance or an overdraft, because the need rises and falls with your sales ledger and so should the borrowing. A gap driven by stock points at a revolving facility or trade finance, drawn when you buy and repaid when you sell. An asset points at asset finance or hire purchase over the asset's life. A one-off step change points at a term loan.
What you want to avoid is funding a permanent, recurring gap with a fixed-term loan that amortises. The gap does not go away, but the loan balance does — so in eighteen months you have made every repayment, still have the same gap, and no facility left. The cost comparison between these options is not obvious from the headline rate either, which is why flat rate, APR or factor rate is worth reading before you sign anything.
Before you borrow, check whether you need to
The calculation cuts both ways. If your gap is £93,000 and 50 of the 62 days are debtor days, the cheapest funding available to you is not a lender at all — it is getting paid faster.
On that illustrative business, pulling debtor days from 50 to 35 releases (15 ÷ 365) × £600,000 = £24,700 of cash. Permanently, at no interest. That is most of the £27,900 the growth was going to require, and it comes from invoicing on the day the job finishes and running the reminders described in how to chase late invoices without losing the client.
Extending your own creditor days does the same thing in reverse, though with a warning: stretching suppliers without agreeing it first is how you end up on pro forma terms, which costs far more than the cash it freed up.
What to do this week
Pull the three numbers. Work out your requirement in pounds and your cycle in days. Do it again using your busiest month. Then split the total into the part that is genuinely a permanent operating gap and the part that is a one-off, and only then decide what to ask for.
You will walk into the lender conversation with a specific figure and a sentence explaining exactly what it funds. That is a different conversation from the round-number one, and it is the difference between an approval and a request for more information — as what a lender actually asks for before they approve a business loan sets out in detail.
Common questions
Is the working capital gap the same thing as a cash flow forecast?
No, and you want both. The gap is a single figure telling you how much cash is structurally locked into operating at your current size, which is what sizes a facility. A cash flow forecast is a week-by-week or month-by-month timeline of money in and money out, which is what tells you when the pressure points fall. The gap answers how much to borrow; the forecast answers when you will draw on it and when you can repay. A lender assessing an application will generally want to see the forecast, and will work out the gap from your accounts whether or not you have.
Should I borrow the exact number the calculation gives me?
Add headroom, but decide the headroom deliberately rather than rounding up out of nerves. A common approach is to size a facility at the peak-month requirement plus 15 to 20%, because your figures come from history and the future rarely matches it exactly. With a revolving facility such as an overdraft or invoice finance this costs you very little, since you generally pay for what you draw rather than what is available. With a term loan the headroom costs real interest from day one, so the case for padding it is much weaker and the discipline of a tighter number is worth more.
Does reducing debtor days really replace borrowing?
Often, for a meaningful chunk of it. Every day you cut off your average debtor days releases roughly one day of sales in cash, permanently and at no interest. On £600,000 of annual sales that is about £1,640 per day of improvement, so moving from 50 days to 35 frees around £24,700. It will not usually replace the whole requirement, because stock and the natural payment cycle put a floor under the gap, but it is the cheapest funding available and lenders view an applicant who has already done it far more favourably than one who has not.
Why do lenders care so much what the money is for?
Because the purpose tells them how the loan gets repaid, which is the only question that actually matters to them. Funding an asset repays itself out of the productivity or cost saving the asset creates, over a life the lender can estimate. Funding a working capital gap repays out of the sales cycle. Funding a loss does not repay at all, which is why vague answers like general cash flow purposes cause applications to stall. A specific figure tied to a specific mechanism, evidenced by your own numbers, is the single biggest thing separating a straightforward approval from a long back-and-forth.
