Working Capital Management: Turn Profits Into Cash
Profitable on paper but cash-strapped in reality? Master AR, AP, and inventory management to improve your cash conversion cycle.
Key Takeaways
- •Profit and cash are different—profitable companies fail from cash shortages when working capital is mismanaged
- •The cash conversion cycle (CCC) is the single most important metric for working capital efficiency
- •Every component of CCC (AR, AP, inventory) offers specific optimization levers to free up cash
- •Working capital financing should be arranged when your business is strong, not during a cash crisis
- •13-week cash forecasting is the discipline that prevents cash surprises and enables proactive management
You've built a profitable business. Revenue is growing, margins are healthy, and your P&L looks strong. Yet somehow, you're always scrambling for cash. Payroll feels tight. You delay vendor payments. Growth opportunities pass because you can't fund them.
This isn't unusual. Many profitable businesses struggle with cash because they haven't mastered working capital management. The good news: working capital optimization offers significant, often untapped opportunity to improve cash position without changing your business model.
This guide covers working capital management for established businesses ($5M-$50M revenue). We'll explore why profitable companies run out of cash, how to measure and improve your cash conversion cycle, and specific strategies for accounts receivable, accounts payable, and inventory optimization.
Why Profitable Companies Run Out of Cash
Understanding the disconnect between profitability and cash flow is the first step toward better working capital management. The issue comes down to timing.
Profit (Accrual Basis)
- Revenue recognized when earned
- Expenses recognized when incurred
- Includes non-cash items (depreciation)
- Ignores timing of actual payments
- Measures economic performance
Cash Flow (Reality)
- Cash received from customers
- Cash paid to vendors, employees
- Only actual cash movement counts
- Timing is everything
- What you can actually spend
The Timing Gap
Consider a simple example. You sell $100,000 of products in January:
Cash Flow Timeline
Result: You showed $30K profit in January, but you were out $60K in cash for 4+ months. Scale this across your business, and you understand the cash crunch.
The Growth Trap
Growth makes this worse. Every new dollar of revenue requires working capital investment before you see cash. The faster you grow, the more cash you consume before it returns.
Rule of thumb: every $1 of revenue growth requires $0.10-$0.30 in additional working capital, depending on your industry and business model. A company growing from $10M to $15M in revenue might need $500K-$1.5M in additional working capital—cash that must come from somewhere.
The Cash Conversion Cycle Explained
The Cash Conversion Cycle (CCC) is the master metric for working capital management. It measures how many days it takes to convert inventory purchases and other resource investments into cash from customer payments.
Cash Conversion Cycle Formula
DIO (Days Inventory Outstanding) = How long inventory sits before sale
DSO (Days Sales Outstanding) = How long customers take to pay
DPO (Days Payable Outstanding) = How long you take to pay suppliers
Understanding Each Component
Days Inventory Outstanding (DIO)
DIO = (Average Inventory / COGS) x 365
Measures how long products sit in inventory before being sold. Lower is generally better (less cash tied up), but too low risks stockouts. Industry-dependent: perishables might target 10-15 days; equipment manufacturers might have 90+ days.
Days Sales Outstanding (DSO)
DSO = (Average Accounts Receivable / Revenue) x 365
Measures how long customers take to pay after invoicing. Lower is better—you want cash faster. If terms are Net 30, DSO should be near 30-35. DSO of 45+ on Net 30 terms indicates collection problems.
Days Payable Outstanding (DPO)
DPO = (Average Accounts Payable / COGS) x 365
Measures how long you take to pay suppliers. Higher means you're using supplier financing (good for cash), but must balance against relationship damage and lost early payment discounts.
CCC Improvement Example
| Metric | Current | Improved | Change |
|---|---|---|---|
| Days Inventory Outstanding | 75 days | 55 days | -20 days |
| Days Sales Outstanding | 48 days | 38 days | -10 days |
| Days Payable Outstanding | 28 days | 35 days | +7 days |
| Cash Conversion Cycle | 95 days | 58 days | -37 days |
The Cash Impact
For a $20M revenue company with 50% COGS, a 37-day CCC reduction frees up approximately $2M in cash. That's capital you no longer need to borrow or raise—it comes directly from operational efficiency.
Accounts Receivable Best Practices
Accounts receivable represents cash you've earned but haven't collected. Every day that cash sits in AR is a day you can't use it. Reducing DSO is often the highest-impact working capital improvement available.
Invoice Fast, Invoice Right
Invoicing Best Practices
- Invoice immediately: Same day as delivery or service completion. Every day of delay is a day added to DSO.
- Get it right the first time: Errors and disputes delay payment. Verify PO numbers, pricing, and delivery details before sending.
- Make payment easy: Include all payment methods, account numbers, and clear instructions on every invoice.
- Electronic delivery: Email invoices directly to AP contacts—physical mail adds days.
Payment Terms Strategy
Shorten Standard Terms
- Consider Net 15 or Net 20 vs. Net 30
- New customers earn longer terms over time
- Large orders may warrant shorter terms
- Industry norms matter—don't price yourself out
Early Payment Discounts
- "2/10 Net 30" = 2% discount if paid in 10 days
- Equivalent to 36%+ annualized return
- Attractive to cash-rich customers
- Track uptake and adjust as needed
Collect Upfront When Possible
- Deposits: 25-50% deposit on large orders or new customers
- Progress billing: Bill milestones rather than on completion
- Retainers: For ongoing services, bill monthly in advance
- Credit cards: Accept cards for smaller amounts—the 2-3% fee may be worth immediate payment
Systematic Collections Process
Effective collections isn't aggressive—it's systematic. Most late payments result from oversight or process issues on the customer side, not inability to pay.
| Timing | Action | Method |
|---|---|---|
| Invoice sent | Confirm receipt | |
| 7 days before due | Friendly reminder | |
| Due date | Payment due notice | |
| 7 days past due | First follow-up | Email + phone |
| 14 days past due | Escalate contact | Phone to decision-maker |
| 30 days past due | Formal demand | Letter + account review |
| 60+ days past due | Collections escalation | Payment plan or collection agency |
The 80/20 of Collections
Often 80% of past-due AR comes from a small number of customers. Identify your chronic slow payers and address root causes: Do they have process issues? Cash problems? Disputes? Sometimes the solution is tighter credit terms; sometimes it's fixing your own invoicing.
Accounts Payable Optimization
Accounts payable is the flip side of the working capital equation. Longer payment terms mean you hold onto cash longer—but there are important tradeoffs to consider.
Strategic Payment Timing
Payment Timing Principles
- Use your terms: If terms are Net 30, pay on day 30—not day 10. Early payment without discount is free financing to suppliers.
- Batch payments: Weekly or bi-weekly payment runs are more efficient than daily.
- Don't damage relationships: Consistently paying late harms supplier relationships and may affect service.
- Prioritize strategically: If cash is tight, prioritize critical suppliers and those with limited alternatives.
Early Payment Discount Analysis
Early payment discounts seem small (2%) but represent significant annualized returns. Whether to take them depends on your cost of capital.
Discount Analysis: 2/10 Net 30
The offer: 2% discount for paying in 10 days instead of 30 days
The math: You earn 2% for accelerating payment by 20 days
Annualized return: 2% x (365/20) = 36.5% per year
Decision rule: If your cost of capital is below 36.5%, take the discount. If you're borrowing at 8-12%, early payment discounts are highly attractive.
Negotiating Better Terms
Leverage Points
- Volume commitment
- Long-term contract
- Prompt payment history
- Consolidated purchasing
- Strategic partnership
Terms to Negotiate
- Net 30 to Net 45 or Net 60
- Better early payment discounts
- Consignment arrangements
- Deferred billing on large orders
- Seasonal payment flexibility
Corporate Cards for Float
Corporate credit cards provide 20-50 days of float (time from purchase to payment due). For expenses that can go on cards, this extends your effective payment terms at no cost (assuming you pay the balance in full monthly).
Inventory Management for Cash Flow
For product-based businesses, inventory often represents the largest working capital investment. Every dollar in inventory is a dollar not in your bank account. The challenge: balance cash efficiency against stockout risk.
The True Cost of Inventory
Inventory Carrying Cost Components
Cost of capital: 8-15% (opportunity cost of cash tied up)
Storage costs: 2-5% (warehouse, utilities, handling)
Insurance: 1-3%
Obsolescence/shrinkage: 2-10% (varies by product type)
Taxes: 1-2% (inventory taxes in some jurisdictions)
If you carry $2M in inventory with 25% carrying cost, that inventory costs $500K per year beyond the purchase price—$42K per month in hidden costs.
Inventory Optimization Strategies
ABC Analysis
Categorize inventory by value and velocity:
- A items: High value, high velocity—tight inventory control, frequent reordering
- B items: Moderate value/velocity—standard management
- C items: Low value, low velocity—may carry more, order less frequently
Safety Stock Optimization
Safety stock protects against stockouts but ties up cash. Right-size based on: demand variability, lead time variability, and cost of stockout vs. cost of carrying. Many businesses carry 20-30% more safety stock than optimal.
Slow-Moving Inventory Action
Identify items with no movement in 90+ days. Options: discount and sell, bundle with fast movers, return to suppliers (if possible), donate for tax benefit, or write off. Dead inventory is the worst working capital investment.
Supplier Relationship Strategies
- Reduce lead times: Shorter lead time = lower safety stock needed
- Vendor-managed inventory: Supplier owns inventory until you use it
- Consignment: You don't pay until product sells
- Drop shipping: Never touch the inventory at all
The Inventory-Cash Tradeoff
Reducing inventory improves cash but increases stockout risk. Quantify both: What does a stockout actually cost you (lost sales, expedited shipping, customer churn)? Compare to carrying cost. The math often reveals you can carry less inventory than you think.
Working Capital Ratios and Benchmarks
Monitoring working capital requires tracking key ratios over time and comparing to relevant benchmarks. Here are the metrics that matter most.
Liquidity Ratios
| Ratio | Formula | Target Range | Interpretation |
|---|---|---|---|
| Current Ratio | Current Assets / Current Liabilities | 1.2 - 2.0 | Overall short-term liquidity |
| Quick Ratio | (Cash + AR) / Current Liabilities | 1.0+ | Liquidity without selling inventory |
| Cash Ratio | Cash / Current Liabilities | 0.2 - 0.5 | Immediate payment capability |
Efficiency Ratios
| Ratio | Formula | What It Tells You |
|---|---|---|
| DSO | (Avg AR / Revenue) x 365 | How fast customers pay |
| DIO | (Avg Inventory / COGS) x 365 | How fast inventory turns |
| DPO | (Avg AP / COGS) x 365 | How fast you pay suppliers |
| CCC | DIO + DSO - DPO | Days cash is tied up in operations |
| Working Capital Turns | Revenue / Avg Working Capital | Efficiency of working capital use |
Industry Benchmarks
Working capital metrics vary significantly by industry. Use these as rough guides, but prioritize benchmarking against your specific industry peers.
| Industry | Typical CCC | DSO Range |
|---|---|---|
| Retail (grocery) | -10 to +10 days | 2-5 days |
| Professional Services | 30-60 days | 45-75 days |
| Wholesale Distribution | 40-70 days | 35-50 days |
| Manufacturing | 60-120 days | 40-60 days |
| Construction | 60-90 days | 50-70 days |
Track the Trend
More important than hitting a specific benchmark is improving your own metrics over time. Track DSO, DIO, DPO, and CCC monthly. Set improvement targets and measure progress. A 10% improvement in CCC often matters more than matching an industry average.
Financing Options for Working Capital
Even well-managed working capital sometimes needs external financing—for seasonal peaks, growth initiatives, or unexpected needs. Understanding your options helps you choose the right tool and negotiate better terms.
Revolving Line of Credit
The Most Flexible Option
How It Works
- Pre-approved credit limit (e.g., $500K-$5M)
- Draw and repay as needed
- Interest only on amount borrowed
- Typically 1-3 year commitment
Best For
- Seasonal working capital needs
- Bridging timing gaps
- Unexpected opportunities
- Safety net / financial flexibility
Asset-Based Lending (ABL)
Borrowing Against AR and Inventory
How It Works
- Borrowing base tied to eligible AR (80-90%) and inventory (50-70%)
- Monthly or weekly borrowing base reports
- Advance rate varies by collateral quality
- More structure than traditional line of credit
Best For
- Companies with strong AR/inventory but weaker profitability
- Higher leverage than traditional bank loans
- Rapid growth requiring working capital
- Turnaround situations
Factoring / Invoice Financing
Selling Receivables for Immediate Cash
How It Works
- Sell invoices to a factor at discount (2-5%)
- Receive 80-90% of invoice value immediately
- Factor collects from customer
- Remainder (less fees) paid when collected
Best For
- Businesses that can't qualify for traditional credit
- Very rapid growth outpacing bank capacity
- Industries where factoring is common
- Short-term bridge financing
Note: Factoring is expensive (20-40%+ annualized cost). Use strategically, not as permanent financing.
Supply Chain Financing
Large buyers sometimes offer supply chain financing programs. The buyer's bank pays you early (at a discount), and the buyer pays the bank on original terms. You get faster payment; the buyer extends their effective payment terms.
Increasingly common with large retailers and corporations. Worth exploring if you sell to Fortune 500 or large regional companies.
Get Financing Before You Need It
Banks extend credit when your business is healthy and you don't desperately need it. During a cash crisis, options narrow and terms worsen. Establish credit facilities during good times. A line of credit costs little if unused but provides crucial flexibility when needed.
13-Week Cash Flow Forecasting
The 13-week cash flow forecast is the essential discipline for working capital management. It provides visibility into your near-term cash position, identifies potential shortfalls before they become crises, and enables proactive decision-making.
Why 13 Weeks?
- Long enough: Captures most payment cycles and seasonal patterns
- Short enough: Forecasts can be reasonably accurate
- Actionable: Enough time to respond to identified issues
- Industry standard: Banks and lenders commonly require it
Forecast Structure
Weekly Cash Flow Format
Beginning Cash Balance
+ Cash Receipts
Customer collections (by major customer or aging bucket)
Other receipts (interest, asset sales, etc.)
- Cash Disbursements
Payroll and benefits
Rent and facilities
Vendor payments (by major vendor or category)
Debt service (principal + interest)
Taxes
Capital expenditures
Other disbursements
= Ending Cash Balance
Minimum cash requirement
Available borrowing capacity
= Net Liquidity Position
Forecasting Best Practices
Use Actual Payment Patterns
Don't forecast collections based on invoice terms. If terms are Net 30 but customers actually pay in 45 days, use 45 days. Analyze historical payment patterns by customer or customer segment.
Update Weekly
Roll the forecast forward each week. Compare forecast to actual. Analyze variances—why was the forecast off? This discipline improves forecasting accuracy over time.
Model Scenarios
Build base case, optimistic, and pessimistic scenarios. What if your largest customer pays 30 days late? What if that big deal closes early? Scenarios prepare you for reality.
Include Contingency Actions
If the forecast shows a cash shortfall in week 8, what's the action plan? Draw on line of credit? Delay vendor payments? Accelerate collections? Having a plan before the crisis is invaluable.
The Weekly Cash Meeting
Establish a weekly cash review with key stakeholders: finance, operations, and sales. Review forecast vs. actual, upcoming significant payments, collection status on key receivables, and any emerging issues. This 30-minute meeting prevents cash surprises.
Putting It All Together: A Working Capital Action Plan
Working capital optimization isn't a one-time project—it's an ongoing discipline. Here's a practical action plan to get started.
Step 1: Measure Your Baseline (Week 1-2)
- Calculate your current DSO, DIO, DPO, and CCC
- Benchmark against industry peers
- Identify your largest AR balances and oldest invoices
- Analyze inventory by age and turnover
- Review payment terms with major suppliers
Step 2: Quick Wins (Week 3-4)
- Contact your 5 largest past-due accounts
- Fix invoicing delays (invoice same day as delivery)
- Stop paying invoices early without discount
- Identify obvious slow-moving inventory for liquidation
- Set up a 13-week cash forecast template
Step 3: Systematic Improvements (Month 2-3)
- Implement a formal collections process with timeline
- Review and tighten credit policies
- Negotiate terms with your top 10 suppliers
- Right-size safety stock levels
- Establish or expand credit facilities
Step 4: Ongoing Discipline (Ongoing)
- Weekly 13-week cash forecast updates
- Monthly working capital metrics review
- Quarterly deep-dive on AR aging and inventory turns
- Annual credit facility review
- Continuous improvement targets for CCC
Cash Flow Management Guide
Complete guide to cash flow for growing businesses
Cash Conversion Cycle
Measuring and improving cash efficiency
Accounts Receivable Optimization
Getting paid faster
Accounts Payable Strategy
Optimizing vendor payments
Inventory and Cash Flow
Finding the right balance
13-Week Cash Forecast
The treasury management tool
Credit Facilities Guide
Lines of credit and beyond
Fractional CFO Guide
When and how to engage CFO expertise
Frequently Asked Questions
Why is my company profitable but always short on cash?
This paradox occurs because profit (accrual accounting) and cash flow are different. Profit recognizes revenue when earned, not when paid. If customers pay slowly (high DSO), you carry inventory (high DIO), or you pay suppliers quickly (low DPO), you're essentially financing your customers' purchases. The solution is optimizing your cash conversion cycle to turn profits into actual cash faster.
What is working capital and why does it matter?
Working capital is current assets minus current liabilities—the capital needed to fund day-to-day operations. It matters because insufficient working capital means you can't pay bills, meet payroll, or fulfill orders, even if profitable. Too much working capital means capital is tied up inefficiently when it could be invested in growth or returned to owners.
What is the cash conversion cycle (CCC)?
The cash conversion cycle measures how long it takes to convert inventory and other resource investments into cash from sales. Formula: CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO). A shorter CCC means you generate cash faster and need less working capital to operate.
What's a good cash conversion cycle benchmark?
CCC varies significantly by industry. Retailers might have 30-60 days, manufacturers 60-120 days, and service businesses (no inventory) negative CCC. Compare to your industry peers rather than generic benchmarks. More importantly, track your own trend—reducing CCC by even 10-15 days can free up significant cash.
How do I reduce Days Sales Outstanding (DSO)?
Key strategies include: invoice immediately upon delivery, offer early payment discounts (2/10 net 30), require deposits or progress billing, implement systematic collections follow-up, tighten credit policies for chronic slow payers, and consider factoring for high-volume receivables. Even reducing DSO by 5-7 days materially impacts cash position.
Should I extend payment terms with suppliers to improve cash flow?
Extending payment terms (increasing DPO) improves cash position but has tradeoffs. You may forfeit early payment discounts (2% for 20 days = 36%+ annualized return), damage supplier relationships, or lose preferred customer status. Evaluate the true cost of extended terms versus the cash benefit.
How much inventory should I carry?
Optimal inventory balances stockout risk against carrying costs. Calculate inventory carrying cost (typically 20-30% of inventory value annually including capital cost, storage, insurance, and obsolescence). Then evaluate stockout costs (lost sales, expedited shipping, customer churn). The intersection determines optimal safety stock levels.
What working capital ratios should I monitor?
Key ratios include: Current Ratio (current assets/current liabilities, target 1.2-2.0), Quick Ratio (liquid assets/current liabilities, target 1.0+), Days Sales Outstanding, Days Inventory Outstanding, Days Payable Outstanding, and Cash Conversion Cycle. Track trends monthly and compare to industry benchmarks.
What financing options exist for working capital needs?
Options include: revolving line of credit (most flexible), asset-based lending (borrowing against AR/inventory), factoring/invoice financing (selling receivables), supply chain financing (buyer extends supplier terms), and term loans (for permanent working capital increases). Get financing when your business is strong—banks are reluctant during cash crunches.
How do I build a 13-week cash flow forecast?
Start with beginning cash, then project weekly receipts (based on actual customer payment patterns, not invoice terms) and disbursements (payroll, rent, vendor payments by schedule, debt service, taxes). Update weekly, compare forecast to actual, and analyze variances. This discipline prevents cash surprises and builds forecasting accuracy over time.
Need Help Optimizing Working Capital?
Eagle Rock CFO helps growing companies turn profits into cash. From cash conversion cycle analysis to 13-week forecasting to banking relationships, we bring CFO-level working capital expertise to businesses that need results, not theory.
Schedule a Consultation