When a company needs money, the first instinct is to look outside it, to a bank or an investor. In most businesses that carry stock and sell on credit, a significant amount is already inside, tied up in receivables and goods. That money is cheaper than any loan, because it carries no interest, needs no security and dilutes nobody. It only has to be released.
What working capital is
Net working capital is the difference between the short-term assets that circulate through the business and the short-term amounts owed to suppliers. For cash management purposes it is calculated as stock plus trade receivables less trade payables. All three are the same thing seen from different sides: money that has left the account and not yet come back, offset by money you are holding that belongs to a supplier.
The cash conversion cycle
A more useful measure than the amount is the number of days. The cash conversion cycle adds the average days to collect a receivable and the average days stock sits on the shelf, then subtracts the average days you take to pay suppliers. The result says how many days the company funds someone else’s business out of its own pocket.
A company with EUR 6 million of revenue collects in 75 days on average, holds stock for 60 and pays suppliers in 45. The cycle is 90 days. At roughly EUR 16,400 of daily turnover, that means about EUR 1.5 million is permanently tied up. Shortening the cycle by fifteen days releases close to EUR 250,000 in cash, once, without a single conversation with a lender.
Where the cash comes back fastest
Collection is almost always the largest item and the quickest to fix. In practice that means a named person is responsible for collection, the customer is called before the due date rather than after, the terms in the contract match the terms on the invoice, and there is a rule for when deliveries stop. Companies that introduce only the last of those typically shorten collection by ten to twenty days within a quarter.
Stock is cleared by turnover rather than by value. Every warehouse holds a group of lines that account for a small share of sales and a large share of the money tied up. That group is sold once at a discount instead of being held for years in the hope of a full price.
With suppliers the point is matching terms rather than paying late. If you collect in 75 days and pay in 45, the gap is funded from your own account. Suppliers often accept longer terms once they get a predictable payment schedule in place of occasional delays.
What that cash actually costs
None of this is free. A discount for early payment reduces margin. Clearing slow stock books a loss. Pressure on a supplier can return as worse purchase terms or lower priority in delivery. The comparison is straightforward: if a working capital facility costs eight per cent a year, then a two per cent discount for payment thirty days early costs roughly twenty-four per cent annualised and is more expensive than the loan. A half per cent discount is cheaper. The arithmetic is done measure by measure rather than as a policy.
Why it also matters when the company is sold
A buyer does not take the company empty. They expect a normal level of working capital to come with the business, and the difference between that level and the actual position at completion adjusts the price. A company that collects everything and empties the warehouse just before a sale does not get a better price, because the target is set against a twelve-month average. A permanently shorter cycle does pay, and twice over: the released cash stays with the owner, and the higher cash flow feeds into the valuation.
Where to go next
- What corporate finance advisory covers
- Financing growth: equity or debt?
- Normalised EBITDA and adjustments
- Restructuring or selling under pressure
The first step is to calculate your own cycle from last year’s accounts and see how many days, and how much money, are involved. It is a few hours of work and the figure is usually larger than owners expect.