Working Capital Cycle: Measuring the Speed of Your Business

It’s an effective way to assess how efficiently a business uses its capital.

Is your company humming along like a finely tuned machine — or is it moving a little slow? By calculating its working capital cycle, you can measure how long it takes to turn the purchase of inventory or materials back into cash.

What is the working capital cycle? 

The working capital cycle is also known as the cash conversion cycle. It’s a measure of how efficiently the business is managing its capital, and it can highlight the need for working capital. 

The working capital cycle consists of three parts: 

• Days Inventory Outstanding (DIO) — the number of days between purchasing inventory and selling it
• Days Sales Outstanding (DSO) — the number of days it takes the company to receive payment from the sale 
• Days Payables Outstanding (DPO) — the number of days the company has to pay its bills without incurring a penalty 

How to calculate the cycle 

To calculate the working capital cycle, add DIO and DSO and subtract DPO. 

DIO + DSO – DPO = Working Capital Cycle

Here’s an example. Company X takes 60 days to sell its inventory. Its customers then have 30 days to pay their invoices. Meanwhile, Company X must pay its bills within 50 days. 

60 + 30 – 50 = 40

That means there is a gap of 40 days between the company paying its bills and then getting paid. This is not out of the norm for many industries. But it does mean the company may need to have working capital or financing available to pay for operations during those 40 days. 

Positive and negative cycles

The above case is an example of a positive working capital cycle, but some companies can achieve a negative cycle. Let’s say a retailer buys inventory on payment terms of 45 days but sells it all within 20 days. Even better, its customers pay cash on receipt so there are zero days sales outstanding. 

 20 + 0 – 45 = -25

In this case, the company has a working capital cycle of -25 days. There are 25 days where the company has already been paid and has the cash ready to pay what it owes on the inventory. A negative cycle can actually be a good thing because it shows the business is operating efficiently. 

Shorter cycles are better, too, because a business has more opportunities to buy inventory and generate revenue. Company A has a working capital cycle of 40 days, but what if a competitor’s cycle is only 20 days long? All else being equal, the competitor can sell twice as much as Company A. 

How to improve your company’s working capital cycle

Companies can reduce the length of their working capital cycle by reducing DIO or DSO and increasing DPO. That could mean:

• Invoicing faster — which makes it possible for customers to pay you sooner, reducing DSO
• Giving discounts for early payment — another tactic for improving DSO
• Paying invoices when they’re due, but no earlier — which lengthens DPO

Managing the working capital cycle becomes more important during periods of high inflation. If a company buys inventory for $10,000 and gets paid 90 days later, the money it receives will be worth less on a dollar-to-dollar basis than what it paid initially. Getting paid faster reduces the opportunity for inflation to erode the dollar’s value. It also lets the company reinvest in new inventory faster, ahead of price increases. 

One thing to note: Calculating the working capital cycle only makes sense for companies with inventory to manage, such as retailers. The cycle wouldn’t be useful for software as a service businesses, for example. 

The bottom line

If you want to optimize your company’s working capital cycle, then you should take a closer look at C2FO’s solutions for working capital. With C2FO Early Pay, businesses can easily accelerate payment from participating enterprise customers. Learn more here.