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Why You Need To Master Your Working Capital Cycle

March 5, 2024
Andrew Knowles

Are you comfortable that you have a firm understanding of your working capital cycle?

In short, your working capital cycle is the time it takes for your business to generate cash.

This cycle is at the heart of how businesses work. You buy something (stock, skills, vehicles, machinery) and you sell that thing, either as a product or a service. Here's how it can look:

  • You invest in equipment and labour to do a job.
  • You do the work.
  • You invoice the client for the work.
  • The client pays you.

The process can take days, weeks or even months. That depends on the nature of the job.

All that time in between you paying out for the resources you need to do a job, and getting cash back when your invoice is paid, is your working capital cycle.

In basic terms, the faster you can do this, the more control you have over your business and the faster you can grow it.

Where your working capital cycle can break down

Cashflow management, or the lack of it, can make or break your business.

Unfortunately, most businesses fail because their cashflow, that is, their working capital cycle, breaks down. While their activities may generate profits, these profits don't convert into cash quickly enough to keep the business going.

Disruptions to the working capital cycle can include:

  • A major customer fails to pay on time.
  • An unexpected tax bill arrives and must be paid.
  • A supplier cuts the credit period they allow.
  • Circumstances delay your work, meaning you're forced to invoice later than planned.

Like most businesses, yours probably doesn't have much cash held in reserve, which you can call on in an emergency cashflow situation.

When the working capital cycle works smoothly, you don't need much spare cash in the system. You know what you're paying out and when, and you know what's coming in and when.

But the unexpected happens. This is why it's good to have a cashflow plan B - something you can call on when your working capital is under pressure.

How to improve your working capital cycle

Does your business have a positive or negative working capital cycle?

Curiously, the one you want is a negative cycle. It's negative, because you get paid faster than you have to spend.

How is that possible? In simple terms, as a retailer you might buy stock on credit, but sell it for cash. By the time you're required to pay your supplier, you've already sold enough of the inventory to pay the bill.

However, your business, like most, probably operates on a positive working capital. That is, you need to pay your suppliers before you get paid by customers.

There are steps you can take to improve this cycle. These include:

Avoid overstocking

All that inventory you're carrying represents cash tied up in products. These may be items you sell, or that you use in the course of running your business. Review your purchasing and selling patterns to determine whether you need that much stock. Of course, you may get discounts for buying in bulk, so you need to determine which quantities are the most efficient for cost-effective purchasing.

Review how you handle tax

Tax, particularly VAT, can be a major cashflow headache for businesses. Is it possible that you could manage these more effectively? Consider taking professional advice, such as talking to your accountant, about different ways of managing your tax obligations.

Shorten your credit terms

When did you last review the credit terms you offer to your customers? Rather than making a universal change to your terms for all accounts receivable, you could focus on your largest customers and have a conversation with them about the number of days credit you allow them. While no one likes being asked to pay earlier, you may find that some are not as closed to the idea as you might think. Alternatively, you could offer discounts for early settlement.

Introduce invoice finance

Another way to improve the working capital cycle, through accounts receivable, is to use invoice finance. Rather than being paid after, say, 30 days, you could be paid immediately you raise the invoice. The payment comes from an invoice finance provider, not the customer. This can make a significant improvement to your working capital cycle, even when you take the provider's fee into account.

Extend credit with suppliers

If you've been paying a supplier steadily for months, maybe even years, isn't it time you asked whether they'll give you longer credit terms? Take a look at your accounts payable -  who you pay often and how much? There's probably someone there who'd be open to a conversation about being paid later, based on your track record. However, watch out for any extra costs that may come with this.

Tighten up your sales process

Is there scope to shorten the time it takes to make a sale? In the same way that you need a firm grip on your working capital cycle, you should also know what's happening with your sales cycle. Maybe the number of days between getting a lead to signing a contract can be shortened. This helps more than just cashflow. It can also boost your revenue.

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How to calculate your working capital cycle

If you want to get serious about measuring your working capital cycle in detail, and seeing how changes may improve it, there's a calculation you can perform.

In basic terms it's this: Inventory Days (how long it takes to sell your stock) plus Receivable Days (how much credit you give customers) minus Payable Days (how much credit you get from suppliers) equals your working capital cycle.

Let's say you purchase stock on 30 days’ credit. On average, it takes you 45 days to sell all that stock. Your customers have an average credit term of 14 days.

That's 45 Inventory Days plus 14 Receivable Days, totalling 59 days. Minus the 30 Payable Days and your working capital cycle is 29.

In other words, you have working capital tied up in unsold stock for 29 days. There's a cost to having cash tied up this way.

If you can make changes that reduce your working capital cycle to 23 days, you've cut the cycle by around 20%. This could make a significant difference.

Calculating your actual working capital cycle is probably more complicated, particularly if you're in manufacturing or provide services rather than selling inventory. But the principle remains the same.

Talk to us about improving your working capital cycle

Fast, professional and supportive. These are common sentiments we hear in the feedback from our clients. This tells us that we're doing the right thing for business owners like you.

We frequently get calls from people who need cash to grow their business. They know there's an opportunity, they're confident in their capability to deliver, and all they need is an injection of capital.

When you call, we'll ask why you want to raise funds and how you plan to use them. Then we'll match you with one or more appropriate funders (we work with around 250) and help you through the application process.

Our job is to help you get the working capital you need, when you need it, at a cost that's affordable.

If you want to know more about how we could help you improve your cashflow, get in touch today.

Jamie Davies
Managing Director

As a founder of multiple businesses, Jamie believes that mindset, discipline and ambition are key drivers for success, both for his businesses and for his clients. 

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