Operating a business often feels like you’re riding an endless cycle of activities that are reliant on one another in order to help your business grow.
A great example of this is the working capital cycle (WCC). You need money to pay suppliers, lenders, and other expenses but need to generate sales to make cash payments. However, to make sales, you need to invest more… and on and on.
That’s why business owners continually look for ways to optimize their working capital cycle. By keeping their WCC under control, they can protect and increase their cash flow. Healthy companies understanding WCC and all its metrics is the first step to weighing a business’s current assets and liabilities, allowing leaders to make well-informed strategic decisions that will affect their bottom line over the long term.
What is the Working Capital Cycle (WCC)?
In business, access to cash is your lifeline to success. Without it, innovating to grow your business is nearly impossible. You also can’t pay your bills, repay loans, or meet payroll. Working capital is the cash you have on hand to stay financially healthy, meet your obligations, and plan for the future. It’s often found on a company’s balance sheet.
Average working capital is calculated by subtracting your current liabilities (e.g., accounts payable, taxes, loan interest) from your current liquid assets (e.g., cash, accounts receivable, inventory).
Working Capital = Current Liabilities – Current Assets
Negative working capital means that a company might be struggling to meet its financial obligations. Positive working capital indicates sound financial health and sufficient funds to pay bills and invest in growth opportunities.
The time it takes to convert current assets and current liabilities into cash is known as the working capital cycle (WCC).
A long cycle signals that your business is tying up capital for a more extended period without earning a return. Short cycles indicate your ability to free up cash faster, making your business more agile and poised to grow sooner.
Important Working Capital Metrics
Because every transaction in your business happens at different times and frequencies, it’s critical to properly manage your WCC to improve its short-term liquidity (access to cash) and overall efficiency.
A business’s WCC is calculated using the three different metrics listed below. All values are calculated as the number of days involved to complete each phase in the metric:
Days Sales Outstanding (DSO)
DSO refers to how long it takes to receive payment from customers. For customer-facing businesses, this is usually only a few days for credit card processing. The DSO for companies that provide credit directly to their customers can be significantly longer. Learn how to reduce it here.
Days Payables Outstanding (DPO)
DPO is the opposite of DSO. This metric represents your company’s average payment terms to meet its financial obligations. For example, companies who pay their employees on a 30-day cycle will often have a DPO of 30 (30 days). Other payables included under DPO are things like rent, interest on lines of credit, and money owed to vendors.
Days Inventory Outstanding (DIO)
Another metric is DIO. DIO measures the average period of time that a company holds onto inventory on shelves, in the warehouse, or in transit before it’s sold. The lower the inventory days figure, the fewer days that cash is tied up in inventory. Days inventory outstanding is sometimes known as days in inventory (DII) and days sales of inventory (DSI).
DSO, DPO, and DIO are the values used to determine your WCC, also known as Cash Conversion Cycle (CCC). The CCC helps you assess how well you manage your working capital and gives you a snapshot of your overall financial position. For example, shorter CCC time lags indicate a company that turns its working capital more frequently during the year. Besides having better cash flow, the company generates more sales and higher profits.
How to Calculate Days Working Capital (Working Capital Optimization Cycle)
To calculate your WCC, you must first figure out the DSO, DPO, and DIO values.
- DSO is calculated as accounts receivable divided by one day of sales
- DPO is determined by dividing your accounts payable by one day of cash operating expenses
- DIO is calculated by dividing the average (or ending) inventory balance by COGS (cost of goods sold) and multiplying by 365 days. You can also divide 365 days by the inventory turnover ratio.
Then, you apply these figures to the capital cycle formula to come up with the final number:
Working Capital Cycle (WCC) = DIO + DSO – DPO
Let’s look at an example of how this formula calculates a company’s WCC by looking at a single product’s sales and inventory lifecycle.
Company A purchases a product from a supplier on a 30-day payment term. The merchandise is placed on the shelf and takes 60 days to sell. Once sold, it takes another four days for the customer’s credit card transaction to be processed before the retailer receives the funds.
In summary, the retailer:
- Receives the merchandise on Day One
- Pays the supplier for the merchandise on Day 30 (DPO)
- Sells the merchandise on Day 60 (DIO)
- Receives the cash from the customer’s credit card bank on Day 64, 4 days after the sale (DSO)
Now we apply those values to the formula:
Working Capital Cycle (WCC) = 60 + 4 – 30
By applying the formula, the retailer has a WCC of 34 days. This means the company has 34 days of working capital tied up as merchandise on the shelf. Keeping high inventory levels of products in the warehouse results in higher carrying costs, negatively affecting your WCC.
Why is Optimizing Working Capital So Important?
Simply put, optimizing your working capital and lowering your WCC gives you better cash flow and access to money sooner rather than having it sit in the cycle. More cash means you can repay debts sooner or invest in innovations that grow your business.
You can help improve your WCC by selling goods faster or negotiating longer credit terms with your suppliers. However, you can also shorten the working capital cycle by adopting process automation that brings you sustainable, long-term results.
How to Shorten the Working Capital Optimization Cycle with Automation
Automation is a fast, efficient way to improve your cash flow, giving you more sustainable access to additional working capital that will help you grow your business.
Ash Conversion International (ACI) specializes in providing innovative tech-based business solutions that improve efficiencies, cut costs, and significantly shorten working capital cycles.
Here are five solutions every business should consider implementing to optimize their financial picture:
Document Conversion
Converting paper documents to digital is the foundation of any automated office. Document conversion involves scanning hardcopy documents to digital format and storing them in a central cloud-based content management repository for quick and easy access through ACI’s FileManager™ solution. Retrieve, edit, and process critical documents such as AP invoices, AR remittances, bills of lading, and human resource records using strict access protocols that maintain security. We arrange document pickup and delivery to our secure facility for scanning, taking the work away from you and your team.
Mailroom Conversion
Automated mailrooms process your incoming mail faster. ACI picks up your physical mail from a secure lock box and transports it to our secure facility to be converted into digital documents. Your team can connect to their incoming mail through any connected device, allowing them to take actions that affect your bottom line sooner.
Remote Deposit Capture
Get faster access to cash with ACI’s Remote Deposit Capture Lockbox solution. This tech-based innovation streamlines your AR processes and automates the capture and deposit of all your cheque remittances into your account at your preferred financial institution. All captured data is available for you to load into your finance system for complete, transparent payment tracking.
Accounts Payable Automation
Optimize your AP department with Ash Conversions’ AP Assistant™, an automated solution that helps free your staff from repetitive manual processes such as mail handling, data entry, and hardcopy approvals. ACI’s AP Assistant™ enables your team to review, approve, and pay invoices faster than manual processing while increasing efficiencies and cutting costs, improving your access to ready working capital.
Accounts Receivable Automation
Improve cash management with ACI’s AR Assistant™. This automated solution makes the customer payment process faster and easier, creating a better online experience. It will also encourage repeat buyers, creating an increase in sales conversions and decreasing customer payment time. Real-time snapshots of your customers’ and partners’ payment habits help you learn more about your company’s financial picture within your company.
Automating your current business processes will position your company to have improved cash flow, decreasing your WCC and allowing you to invest more money in innovation that will put you ahead of your competition.
Optimize & Speed Up Your WCC with ACI’s Hybrid Workplace Program
For over 40 years, ACI has specialized in transforming how companies run their daily business processes with efficient, cost-effective solutions.
As Business Process Automation specialists, our team works with you step-by-step throughout the implementation to have your solutions operational in as little as 30 days. We ensure that every question is answered and that your accounting team is proficient in operating the solutions upon implementation.
All of our systems interface easily with your ERP platform, increasing the overall efficiency of your business while making its processes operate more smoothly than ever. With ACI, you’ll be organically optimizing your working capital cycle, improving your ability to complete growth-oriented initiatives sooner.
Click below to contact us today to learn more about how ACI’s automated solutions can help take your business into the future.
