How to work out your working capital needs

Money tied up in stock you have not sold and invoices nobody has paid. It is real, and it grows with you.

Working capital is the cash locked in day-to-day operations. You pay suppliers before customers pay you, and the difference has to be funded.

Step-by-step

1. Enter average stock held, in days of sales.
2. Enter how long customers take to pay.
3. Enter how long you take to pay suppliers.
4. Read the cash conversion cycle and the funding required.

The cash conversion cycle

Days of stock, plus days to collect from customers, minus days you take to pay suppliers. The result is how long your money is tied up.

Hold 45 days of stock, collect in 60, pay in 30: your cycle is 75 days. You fund 75 days of trading continuously, and that money never comes back while you keep operating — it simply cycles.

Growth makes it worse

This is the point people miss. Doubling sales roughly doubles working capital, because you hold twice the stock and are owed twice as much. Growth therefore consumes cash exactly when everything appears to be going well.

Overtrading — growing faster than working capital can be funded — kills profitable businesses regularly.

The three levers

• Hold less stock. Directly frees cash, at the cost of some risk of running out.
• Collect faster. Invoice immediately, chase early, make paying easy. Usually the largest available gain.
• Pay more slowly, within agreed terms. Do not simply pay late; suppliers remember.

Frequently asked questions

What is the cash conversion cycle?

Days of stock held, plus days to collect from customers, minus days taken to pay suppliers. It is how long your cash is tied up in operating.

Why does growth cause a cash shortage?

Because working capital scales with sales. Double the revenue and you hold roughly double the stock and are owed roughly double, all funded before the money arrives.

What is the fastest way to free up working capital?

Collecting faster, in most businesses. Invoice the moment work is done, chase before the due date, and make it easy to pay.