Guide to the Working Capital Cycle

Q: What are the 4 main components of the working capital cycle?

The four components of the working capital cycle are: Inventory Accounts Receivable Accounts Payable Cash

Q: How is the working capital cycle calculated?

The formula for calculating the working capital cycle is: Inventory Days + Receivable Days - Payable Days = Working Capital Cycle

Q: Is the working capital cycle the same as the operating cycle?

Yes. The working capital cycle is also known as the cash operating cycle. Both terms refer to the number of days between paying suppliers and receiving cash from sales.

Lauren WardUpdated April 9, 2023

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The working capital cycle describes the flow of money in a business, from its suppliers to its customers. It includes all the steps in the production process — buying raw materials, processing them, selling finished goods, and collecting payment for those goods.Generally, shorter working capital cycles are better than longer ones. If a business can sell their inventory quickly, collect customer payments quickly, and pay their vendors for raw materials slowly, they’ll have better cash flow. A long working capital cycle, on the other hand, ties up cash for a longer period of time without earning a return on it.Read on to learn more about what the working cycle capital is, how it’s calculated, and the difference between a positive and negative working capital cycle.

What Is the Working Capital Cycle (WCC)?

By definition, the working capital cycle is the amount of time it takes to convert net working capital (such as current assets and current liabilities) into cash. The longer the cycle is, the longer a business is tying up capital in its working capital without earning a return on it. Therefore, companies generally strive to reduce the working capital cycle by selling inventory faster, collecting payment sooner, and/or stretching accounts payable.

Components of the Working Capital Cycle

There are four key components of the working capital cycle.

Accounts Receivable

Accounts receivable are the funds that customers owe your company for products or services that have been received and invoiced but not yet paid for. A company needs to collect its receivables in a timely manner so that it can use those funds to pay it debts and cover its operating costs.

Accounts Payable

Accounts payable is any money a company owes to its suppliers or vendors for goods or services received but not yet paid for. Businesses generally try to balance payables with receivables to maintain maximum cash flow. Often a company will delay payment as long as they can while still maintaining good relationships with suppliers.

Inventory

Inventory is the product (or products) a company sells and is its main asset. How quickly a company can sell and replenish its inventory is a key measure of its success. Generally, you want enough inventory that you don’t lose out on sales but not so much that you are wasting working capital.

Cash

A business needs to generate enough cash from its activities so that it can meet its expenses and have enough left over to invest in infrastructure and grow the business. If a company doesn’t generate adequate cash to meet its needs, it may have trouble conducting routine activities, such as paying suppliers and buying raw materials, let alone making investments or handling emergency expenses.Recommended: Cash Flow vs Profit Compared

Working Capital Cycle Formula

The working capital cycle formula includes three factors:

Inventory days This refers to how quickly you can sell your stock. It includes the time you spend processing and manufacturing raw materials into products, as well as the time it takes to sell them to customers.
Payable days This is how soon you have to pay suppliers for the stock or raw materials.
Receivable days This is how long it is between selling your stock and receiving payment from customers.

To calculate the working capital cycle, you add the number of inventory days to your receivable days, and then subtract the number of payable days. The working capital cycle formula is: Inventory Days + Receivable Days - Payable Days = Working Capital Cycle in Days

Calculating Working Capital Cycle

Here is an example of how to calculate the working capital cycle using a fictional business called Company ABC.Company ABC follows this working capital cycle:

They purchase supplies and materials needed to manufacture their products on credit. They have 60 days to pay for the materials (Net 60).
It takes the company, on average, 56 days to turn these materials into inventory and then sell that inventory to customers.
Customers pay for the products, on average, within 30 days. Once they get cash payment from their customers, their working capital cycle is complete.

Now, let’s calculate ABC’s working capital cycle formula:Inventory days = 56Receivable days = 30Payable days = 60Working Capital Cycle = 56 + 30 – 60 = 26This number is how many days the business is out of pocket before receiving full payment, and is what’s known as a positive cycle.

Positive vs Negative Working Capital Cycles

	Positive Working Capital Cycle	Negative Working Capital Cycle
Customers pay	Later	Up front
Need to pay vendors	Later	Later
Inventory moves	Slowly	Quickly
Receive cash before needing to pay vendors	No	Yes
Working capital cycle end number	Positive	Negative

It’s normal for a business to have a positive working capital cycle and have a number of days where they are waiting for payment to give them available cash.Companies that have a positive working capital cycle often need some type of financing, such as a line of credit, invoice factoring, or accounts receivable financing, to hold them over until they receive payments from their customers and complete their working capital cycle.A business with a negative cycle, by contrast, has collected money at a faster rate than they need to pay off their bills, which means the end number after using the formula is a negative number. Negative working capital is common in some industries, such as grocery retail and the restaurant business. With these businesses, customers pay up front, inventory moves quickly, while suppliers often give 30 days credit. As a result, the business receives cash from customers before it needs to pay its suppliers.Recommended: Working Capital Lines of Credit vs Loans

Pros and Cons of Shorter Working Capital Cycles

Pros of Shorter Working Capital Cycles	Cons of Shorter Working Capital Cycles
Frees up trapped capital	Negotiating better credit terms with suppliers can lead to higher unit prices
Can quickly turn stock into profit	May involve invoice financing and interest costs
Can invest in and grow your company without taking on debt	May need to be aggressive with account receivables

The Takeaway

The working capital cycle is the time it takes to turn current assets into cash. There are three key factors that affect your working capital cycle: the time needed to pay your supplier, the time needed to sell your inventory, and the time needed to receive payment for your sales.It’s normal for a business to have a positive working capital cycle, meaning there is a delay between being paid by your customers and needing to pay your vendors. Many small businesses rely on working capital loans, such as short-term loans, invoice factoring, and merchant cash advances, to bridge temporary dips in working capital.

3 Small Business Loan Tips

Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can find recommended small business loans by using Lantern by SoFi.
If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Frequently Asked Questions

What are the 4 main components of the working capital cycle?

How is the working capital cycle calculated?

Is the working capital cycle the same as the operating cycle?

Photo credit: iStock/Chalirmpoj Pimpisarn

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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