The longer the working capital cycle is, the more time it takes for your business to get a good cash flow. It’s common for businesses to manage their cycle by revising each step where possible. This could be by selling inventory quicker, collecting payment sooner, and paying bills later on.
There are three main steps in the cycle:
- Pay for assets (for example inventory to sell or equipment for a job).
- Sell inventory (or complete the job for a customer).
- Receive payment on what you’ve sold (funds now available to pay costs).
What affects the working capital cycle?
Factors will vary between industries, but essentially how long it takes you to sell your inventory and how long it is before you receive payment will impact the length of the working capital cycle for your business.
For example, a manufacturing company purchases raw materials on credit from their supplier for a product which they expect to sell in eight weeks’ time to a client. Payment from the client, however, may not come immediately – say, another 30 days – and the manufacturer still needs to pay the supplier before their credit payment terms of 60 days are up.
Working Capital Cycle Formula
To calculate the length of your cycle, or your working capital days, you’ll need to use the working capital cycle formula, also know as the cash cycle formula. In a nutshell, this is: how long it takes to sell the inventory (Inventory Days) plus how long it takes to receive payment (Receivable Days) minus how long you have to pay your supplier (Payable Days) equals length of your business’s Working Capital Cycle.
Using the example above, the working capital cycle for the manufacturer is 26 days:
56 Inventory Days + 30 Receivable Days – 60 Payable Days = 26 days working capital cycle.
This number is how many days the business is out of pocket before receiving full payment, and is what’s known as a positive cycle.
Positive cycle vs negative cycle
It’s perfectly normal for most businesses to have a positive working capital cycle and have a number of days where they are waiting for payment to give them available cash.
A business with a negative cycle has collected money at a faster rate than they need to pay off their bills, which means the end number after using the formula is a minus number.
A negative cycle might be 25 days to sell your inventory, 20 days to receive payment but 60 days to pay off credit:
25 Inventory Days + 20 Receivable Days – 60 Payable Days = -15 days
Many businesses strive for a negative working capital cycle by trying to move inventory at a faster rate, shortening customer payment terms and lengthening their own payment terms.
Improve the working capital cycle and grow your business
It’s completely normal for businesses to be in a positive working capital cycle and have a period of time where there is a gap in available cash, even though the negative cycle is the desirable. If this is the case for you, it is still very possible to continue to grow your business.
How? Glad you asked!
As we mentioned above, there are ways to handle each step of the cycle to maximise your cash flow as much as you can. And – on paper – they’re simple: reduce inventory days, reduce receivable days, and increase payable days.
1. Firstly, get your inventory sold as soon as you can and shorten the length of time you have it on hand. This will also help you avoid stockpiling and could even save you some money on storage costs.
2. To reduce your receivable days, invoice management could be the key. Shorten your invoice terms, offer early-bird discounts, and improve your credit collection process. A popular method for invoice management is to use invoice finance to bring forward the revenue you’re due within a few days of the invoice being raised.
3. Arguably the most difficult step of the cycle to change is the payable days. Ideally, try and lengthen them, perhaps by negotiating credit terms with your suppliers. There is also the option to seek alternative funding like a business credit card to pay your costs but it’s incredibly important to be aware of extra costs this might incur, and thus impact your working capital cycle in a way you aren’t aiming for.
Get in touch
We’ll do our best to help you find a solution to bridging the gap in your cash flow. Many small businesses use forms of financing such as invoice finance, business loans or a revolving credit facility. Touch has a panel of over 35 funders who can provide one or more of these services. We will do our best to put you in contact with the most suitable for your needs.
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