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Working capital cash cycle explained

Working capital cash cycle explained

Working capital is the cash needed to finance the day to day operations of the business. Working capital is necessary to:

  • Pay suppliers for goods and services
  • Pay employees
  • Pay for inventory and work in progress (WIP)
  • Allow customers to buy now, but pay later
  • Pay other creditors i.e. taxes to HMRC

The working capital cycle or cash cycle is measured in days. It is calculated in three parts:

  • Receivables (or debtors) days – this is the average number of days credit given to customers and is calculated by dividing the period-end value for trade debtors (i.e. the cash due to be received from customers at the period end date) from the balance sheet by the revenue for the year and multiplying by 365
  • Inventory and WIP days – this is the average amount of cash tied up in inventory and work in progress during the year and is calculated by dividing the period end value for inventory and work in progress from the balance sheet by the cost of sales for the year and multiplying by 365
  • Payables (or creditors) days – this is this is the average number of days credit given by suppliers and is calculated by dividing the period end value for trade creditors (i.e. the cash due to be paid to suppliers at the period end) from the balance sheet by the cost of sales for the year and multiplying by 365


The cash cycle is the calculated by adding the number of receivables (debtors) days to the number of inventory and work in progress days and then subtracting the number of payables (creditors) days. The larger the number of days in the cash cycle, the more cash that is ‘tied-up’ financing a company’s day to day operations. Companies generally aim to shorten their cash cycle to free up cash for other uses i.e. to finance additional investment or to reduce borrowings. The cash cycle can be reduced by:

  • Reducing the number of days credit given to customers (i.e. invoices are paid more promptly)
  • Reducing the amount of inventory and work in progress
  • Increasing the number of days credit given by suppliers (i.e. invoices payments are delayed)

More important than making a profit, is the ability of a company to convert profit into cash. This requires a business to actively manage its working capital. This is especially the case when undergoing periods of rapid expansion or contraction, both of which can put a severe strain on a company’s management and cash flow.

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