What Is the Importance of a Working Capital Cycle?

08 June, 2022

What Is the Importance of a Working Capital Cycle?

From nonprofits working to make the world a better place to first-generation American who is striving to create their own million-dollar business, money is at the core of what makes everything possible. As a business owner, you understand the significance of money management and how working capital must remain a top priority for success. With all the responsibilities that a business must assume, both short- and long-term, working capital can often be simplified to a single number that needs to be managed. 

However, to be the most successful business, working capital needs to be looked at as a cycle where the focus changes depending on what stage of the working capital cycle a company is in. For this reason, our team at Backd has put together this blog to cover both the importance of working capital and a working capital cycle. 

What Is a Working Capital Cycle?

In general, a working capital cycle is the amount of time it takes to convert a business's net current assets and liabilities into cash. There is no specific amount of time that a cycle is supposed to last. For example, more immediate goals will require shorter working capital cycles in order to free up cash faster.

The first natural course of action for a business is to calculate its working capital cycle. In order to do this, a business needs to break down the four general phases of a working capital cycle.

  • Cash: While there is no order for these phases, an excellent place to start is for a business to evaluate if there is currently a positive cash inflow to manage business operations. 

  • Receivables: These are the set payment terms for any money that is owed on goods and/or services. 

  • Inventory: This phase requires another evaluation where a business needs to determine how long, on average, it takes to sell its inventory.

  • Billing (Payables): How long does it take to pay back suppliers and vendors?

Now that the four phases are defined, we can move to an example of the working capital cycle formula. For most businesses, the formula will work in the same way. The first step is to add together the inventory days and receivable days for a given period. Then, subtract that number from the payable days within that same period. That final number will be a business's working capital cycle in days. 

Inventory Days + Receivable Days - Payable Days = Working Capital Cycle in Days

Why the Working Capital Cycle Is Important

These evaluations and calculations are great, but can they truly impact the bottom line? Yes, and every business should keep a close eye on their working capital cycle. For organizations that sell products to clients, this financial concept gives a clear picture of how long they can expect their assets to be tied up in other areas like stocks and inventory. The cycle is also important because it is like a health evaluation for your business. When you examine your working capital cycle, and it's not looking as expected, changes need to be made. Where can the business grow? Are there areas where fat can be trimmed to make processes more efficient? These are the kinds of questions that allow the working capital cycle to have less downtime, which means you will be able to make decisions more quickly. This knowledge also impacts all other decisions outlined in a strategic plan. 

How to Improve the Working Capital Cycle

The best way to improve the cycle is by optimizing working capital management itself. Yes, it sounds convoluted at first, but to help set the scene, let's look at a few ways to improve the working capital, and the other pieces will fall into place. 

  • More Efficient Receivables: A major roadblock for the working capital cycle is a business not collecting their receivables fast enough. One way to get over this hurdle is by offering incentives to customers to prompt their payments sooner. This could be a discount for anyone who pays within 60 days, for example. In the end, the money lost from the discount will not be noticeable. 

  • Shortened Inventory Cycles: Inventory has different meanings across varying industries, but it is best practice to trim the possible duration of these periods. This can be through lean manufacturing or more accurate inventory forecasts. Whichever method a company chooses, it should hopefully decrease the time needed for inventory to become sales.

  • Manage Payable Terms: If there is currently no benefit, such as a discount, for making payments to suppliers early, then an organization may want to consider holding onto that money longer than they might think. This money can be used to pay off other debts or invest in current company ventures. In order for this to be a possible way of conducting business, organizations should work to negotiate or pick suppliers who can afford to deal with extended payment periods. 

Backd: Ensure Your Working Capital Works for You

At Backd, we understand the struggles that can arise when it comes to consistent and efficient funding. Running a business is difficult enough without having to jump through hoops to get the financing you need. We have an efficient process to get you the money you need now. That does not mean we can only give small amounts, as the amount can range from $10k-$5M and a term length of up to 14 months.

To get a jumpstart with your new working capital, contact us today.