How can you balance working capital needs with other financial priorities?

1 What is the working capital cycle?

The working capital cycle is the time it takes for your business to convert its inventory and receivables into cash, and then use that cash to pay its payables and other expenses. The shorter the cycle, the more efficient your working capital management is. However, the cycle length depends on various factors, such as your industry, sales volume, credit terms, inventory turnover, and payment policies. You can measure your working capital cycle by calculating the cash conversion cycle (CCC), which is the sum of the days inventory outstanding (DIO), the days sales outstanding (DSO), and the days payables outstanding (DPO). A positive CCC means that you need to finance your working capital, while a negative CCC means that you generate cash from your working capital.

2 How can you improve your working capital cycle?

To improve your working capital cycle, you need to reduce the time it takes to collect cash from customers and sell inventory, and increase the time it takes to pay suppliers and other creditors. To do this, negotiate better credit terms with customers and suppliers, such as discounts for early payments, penalties for late payments, or extended payment periods. Additionally, consider implementing effective inventory management practices like JIT systems or reorder points. Lastly, streamline invoicing and collection processes with electronic invoicing, online payment platforms, automated reminders, or third-party collection agencies. This will help speed up cash inflows and reduce bad debts.

3 How can you balance your working capital needs with other financial priorities?

Improving your working capital cycle can enhance your liquidity and efficiency, but it can also affect other financial priorities, such as investing in long-term assets, reducing debt, or distributing dividends. Therefore, you must balance your working capital needs with these goals and consider the trade-offs and implications of your decisions. When making such decisions, you should take into account the opportunity cost of working capital, the risk of working capital, and the growth potential of working capital. For example, if you have a positive CCC and you need to borrow money to finance your working capital, you will incur interest expenses that could reduce your net income and cash flow. On the other hand, if you have a negative CCC and you reduce your inventory and receivables, you will free up cash but limit your sales potential. Ultimately, careful consideration of these factors can help you make informed decisions about your working capital management.

4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?