Working+Capital+Cycle

Businesses that sell products need inventory to generate revenues. In order to get inventory, businesses often enter into credit agreements with their suppliers so that they don't have to pay cash immediately for the inventory (scroll to the second graphic to see what happens when firms must pay upon delivery). In order to promote more sales, businesses frequently offer credit purchasing opportunities to their customers. Once the inventory has been converted to a sale, the business must wait out the accounts receivable turnover to realize a positive flow of cash from the transaction. The working capital cycle is the total number of days of inventory in stock and accounts receivable period (the amount of time it takes to realize a cash inflow) minus the average number of days the business gets to resolve its accounts payable to suppliers (a cash outflow).


 * While it might seem counterintuitive to some, a business can have a negative working capital cycle. This is a good situation because the business has more capital available to fund growth. Growing businesses need access to cash, and being able to free up cash from the working capital cycle is cheaper than other sources of finance, such as loans.**

In this example, Owen Banksmore has negotiated repayment of his credit from suppliers to be an average of 30 days. He is able to sell the inventory he gets from suppliers, on average, about 60 days. He sold his inventory to his customers on credit; his company takes an average of 60 days to turn its accounts receivables into cash.

Conversely, Florence "Flo" B. Chillin has negotiated superior credit repayment terms from her suppliers - 90 days! - and is faster at getting inventory off her store's shelves, averaging 30 days. She gets her customers, who also purchase on credit, to repay their borrowings in 30 days.

As the graphic shows below, Flo's working capital management practices give her a working capital cycle of -30 days, while Owen's practices yield a WC cycle of 90 days. Flo has more cash to fuel growth and does not need to finance her business' growth with other sources of cash. Download the Excel file for this example here

Some people don't like the idea of owing money. This example shows why small businesses should take advantage of credit policies offered by their suppliers or should try to negotiate for them. In this scenario, both Flo and Owen have to pay cash to their suppliers upon delivery of inventory. Look at the effects this has on the working capital cycle.