How to find the cash trapped in your working capital
A profitable company that is permanently short of cash is not a paradox. It is an arithmetic problem, and the arithmetic is visible in four numbers you already hold.
Working capital is the cash tied up in running the business day to day: money owed by customers, money sitting in stock, less money you have not yet paid suppliers. It has to be funded by someone. If it is not funded by your suppliers, it is funded by your bank or by you.
When revenue grows quickly, working capital usually grows faster. Sales are won on longer credit terms because that is what closed the deal. Stock is built to protect service levels. Suppliers, noticing the growth, tighten their own terms. Each decision is individually sensible and the combined effect is a business that earns a profit it never sees in the bank.
The four measurements
Calculate these from your own ledgers rather than from the annual accounts. Year-end figures are the least representative point in the cycle, because everyone tidies up before the auditor arrives.
| Measure | How to calculate it | What it tells you |
|---|---|---|
| DSO | (Trade receivables ÷ credit sales) × days in the period | How long customers take to pay. Rising DSO with flat terms means collection discipline has slipped, not that customers changed. |
| DIO | (Inventory ÷ cost of goods sold) × days in the period | How long stock sits before it sells. The average hides the problem; the distribution is where the answer is. |
| DPO | (Trade payables ÷ cost of goods sold) × days in the period | How long you take to pay suppliers. Lower than your agreed terms means you are funding them. |
| CCC | DSO + DIO − DPO | Net days your cash is locked in operations. Multiply by daily cost of sales for the rupee figure. |
One calculation makes the size of the prize concrete. Take your cash conversion cycle, subtract the cycle you were running three years ago, and multiply the difference by your daily cost of sales. That is roughly how much extra cash the business is carrying purely because the cycle lengthened.
Where the money usually is
Averages conceal. In almost every case we have looked at, most of the recoverable cash sits in a small number of places.
Receivables: two or three accounts
Sort the ledger by value and then by age. The pattern is usually a handful of large customers on terms nobody formally approved, plus a tail of invoices in dispute for reasons that were never resolved because no one owned resolving them. Disputed invoices are the fastest money in the building — the customer is not refusing to pay, they are waiting for a corrected document.
Inventory: the slowest quartile
Rank stock by turns. The bottom quartile typically holds a large share of value and almost none of the movement. Some of it is genuinely obsolete and being carried at full value, which is a profit problem as well as a cash one. The rest is safety stock set for a smaller, less predictable business and never revisited.
Payables: paying earlier than agreed
Compare actual payment dates against contracted terms, supplier by supplier. Many finance teams pay on receipt out of habit. Where an early-payment discount exists, work out whether the discount rate beats your cost of borrowing — often it does, and paying early is correct. Where there is no discount, paying early is a gift.
What to be careful about
Working capital can be improved in ways that damage the business, and the damage shows up two quarters later when it is hard to attribute.
- Tightening credit terms on a customer who is genuinely growing costs you the growth
- Cutting safety stock without fixing demand forecasting converts a cash problem into a service problem
- Stretching a sole-source supplier gets priced into the next quotation, usually with interest
- A year-end push flatters the closing balance sheet and reverses in April
The test for any intervention is whether it would still be the right decision if the business had plenty of cash. If the answer is no, it is a squeeze rather than an improvement.
Who should do the work
Rarely the existing finance team, and not because they are not capable. A working finance function is running the close, the audit and the compliance calendar. Very few have three uninterrupted weeks to take the receivables ledger apart customer by customer, which is what this requires. It is a project, not a task.
Common questions
What is a good cash conversion cycle?
There is no universal figure, because it depends entirely on the industry. A fast-moving consumer business may run close to zero or negative; a capital equipment manufacturer may run 120 days and be perfectly healthy. The number that matters is your own cycle compared with what it was two and three years ago, and compared with the two or three closest competitors whose accounts you can read.
Can working capital be negative?
The cash conversion cycle can be, and it is an excellent position: it means suppliers are funding your operations because customers pay you before you pay your suppliers. Retail and some subscription businesses achieve it routinely. Most manufacturers cannot, because inventory sits in the middle.
Should we just stretch our suppliers?
It is the fastest lever and the most expensive one. Pushing payables beyond agreed terms damages supply reliability, costs you early-payment discounts, and gets priced back into your next quotation. It is a one-off gain that is usually reversed within two quarters. Receivables and inventory are slower to fix and the improvement stays.
Find out what your number is
Bring your last set of accounts to a thirty-minute call and we can usually give you a rough sense of what is trapped before you commit to anything.