Money Matters

What is a working capital cycle?

working capital

When we talk about cash flow, what we are talking about is the working capital cycle, which is the cash flowing in a repeated cycle in and out of your business. Cash flow the lifeblood of your business and you need to help keep it. If a company is operating profitably, then it should, in theory, generate a cash surplus.

The working capital cycle at its basic level is about who is funding what. While you are waiting for your customers to pay, you are funding their business at your own cost. The reverse is also true, as while your suppliers are waiting for you to pay them they are financing your company at their expense. The cycle is the difference in time between the two payments.

Any way that you can speed up your customer payments and slow down your payments to suppliers will reduce your cycle.

For example:

If you buy 100 laptops from your supplier on 30-day credit terms, they are funding your stock for 30 days. This gives you the time to sell as many of the laptops as you can. If you receive immediate payment, by the end of the 30 days, you will hopefully have sold enough to pay your supplier and have several laptops left to sell which will all contribute to your profit.

If you were to sell the laptops on 30-day credit terms to your customers from the point of sale, you would face the situation where you were liable to pay your supplier in 30 days, but would not be receiving payment from your customers until after that date. You would, therefore, have a funding gap between the time to pay your supplier and the time you get paid.

This is known as the working capital cycle – the time periods between cash payments and receipts. They can be long or short – with shorter cycles being better and less costly to fund.

It can be tempting to pay cash when you have got it. However, if you do pay cash, remember that this is now no longer available for working capital. Similarly, if you pay out dividends or increase your drawings, these cash outflows – like water flowing down a plug hole, can remove the cash liquidity from your business and interrupt your working capital cycle.

By implementing a proper cash flow management process and stock control, you should be able to achieve a short cycle, which will ultimately give you a healthier more profitable business with less risk. Even a little bit of effort can produce more significant results.