What is a working capital cycle?

UK businesses are facing a cash flow crisis, partly due to rising costs and delayed payments.

Over the last three years, the average cash conversion cycle – the amount of time it takes to convert inventory and receivables into cash, minus the time taken to pay suppliers – has increased by three days. This is putting even more pressure on operational cash flow.

But businesses that manage their working capital cycle effectively could unlock thousands in cash reserves.

In this article, we’ll explain what the working capital cycle is, how to calculate it, how to spot potential issues and how to improve working capital.

Key points:

• The working capital cycle measures how quickly your business converts investments into cash

• UK businesses are experiencing longer cycles, with smaller companies particularly affected by extended payment times since 2021

• Funding Options by Tide can help when optimisation of working capital isn’t enough, offering access to business finance up to £20 million

What is the working capital cycle?

Your working capital cycle (WCC) is the time it takes for your business to convert the money you’ve invested in stock and operations back into actual cash in your bank account.

So while working capital tells you how much money you have available, the working capital cycle tells you how quickly that money moves through your business.

Here’s the formula:

Working Capital Cycle (in days) = Inventory Days + Receivable Days - Payable Days

Here’s an example:

1. A UK manufacturing business buys raw materials that take 60 days to turn into finished products (Inventory Days)

2. They give customers 30 days to pay invoices (Receivable Days).

3. They negotiate 45 days to pay their own suppliers (Payable Days).

Their working capital cycle would be: 60 + 30 - 45 = 45 days

In effect, the business has cash tied up for 45 days before it comes back as revenue. And during this time, they’ll need to find other ways to cover their bills and operational costs.

The average working capital cycle varies a lot by sector due to differences in inventory management, payment terms, and receivables. In the UK, the transportation, healthcare, and professional services sectors convert working capital to revenue faster, while real estate and technology sectors tend to have slower cycles.

Understanding your working capital cycle is crucially important. And with working capital finance available to bridge any gaps, many businesses are discovering they don’t have to suffer through long cycles without support.

How do you calculate your working capital cycle days?

Calculating your working capital cycle is simple. You just need three key measurements, each converted into days.

Here’s a reminder of the formula:

Working Capital Cycle (in days) = Inventory Days + Receivable Days - Payable Days

So based on the above information, your working capital cycle would be: 61 + 37 - 44 = 54 days.

In effect, your cash would be tied up for nearly two months before returning as revenue. For a business with monthly operating costs of £25,000, this represents £50,000 in financing needs just to maintain normal operations.

Understanding these numbers can help you see where improvements might have the biggest impact. For example, if you could reduce receivable days from 37 to 30, you’d free up £7,500 in cash flow without changing anything else about your business.

Why is your working capital cycle getting longer?

The Cash Conversion Cycle has lengthened by an average of three days for mid-market UK businesses over the last three years.

Smaller companies are being hit particularly hard – since 2021, smaller businesses show increased Days Sales Outstanding (DSO), meaning longer collection times for receivables and thus stretched working capital cycles.

Several factors are driving these longer cycles:

• Late payment culture has become entrenched in UK business, with some customers routinely paying beyond agreed terms.

• Economic uncertainty has made businesses more cautious about cash management, leading to slower payment decisions.

• Supply chain disruptions have forced many companies to hold higher inventory levels as a buffer against shortages, extending the inventory days component of the cycle.

• The rise of longer payment terms as a competitive tool has also contributed, with businesses increasingly feeling pressured to offer 60 or even 90-day payment terms to win contracts.

For many businesses, invoice finance has become a valuable way of helping manage these extended cycles. It helps businesses access up to 90% of invoice values within 24 hours, speeding up the weeks and months it can take to receive customer payments.

What are the warning signs of working capital cycle issues?

Mismanaging working capital could weaken your financial stability, leaving your business struggling to cover debts and operating expenses. So recognising the early warning signs of working capital cycle issues can help you maintain a more healthy cash flow.

Here’s what to look out for:

• Lengthening payment cycles: If your 45-day payment cycle stretches to 50 days, then 55, consider this a red flag. A steady month-on-month increase in cycle length could signal a deeper issue that needs to be addressed quickly.

• Tightening cash flow: If you start missing supplier payments or delaying salaries, it could be a sign that your cash flow cycle is no longer sustainable with your current cash reserves.

• Over-reliance on costly short-term financing: Regularly using credit cards or factoring facilities to cover day-to-day expenses could indicate that your working capital cycle needs improving. Although short-term financing can be useful, relying on it regularly might point to more serious underlying problems.

• Inventory growth without sales: If rising stock levels aren’t matched by increased sales, this could indicate inefficient inventory management. Unsold inventory ties up cash.

• Customers paying late: If your customers consistently pay later than the agreed terms, it might be time to review how you manage receivables. Ignoring this could strain your cash flow even further.

If your business shows any of these warning signs, working capital finance could provide you with much needed breathing room while you make improvements. But the financing should support cycle improvements rather than simply masking the underlying problems.

How can you improve working capital cycle speed?

The fastest way to improve your working capital cycle is to focus on what you can control most easily. For most businesses, that means starting with receivables management rather than trying to push for longer payment terms with suppliers.

• Speed up receivables collection: This is where you’ll likely see the quickest results. You could try offering small discounts for early payments – even a 1% discount for payment within 10 days could boost your cash flow. The cost is often lower than the financing fees you’d pay while waiting for standard payments.

• Automate invoicing and follow-ups: Manual invoicing slows everything down. So instead of batching invoices each month, consider sending them immediately after delivery. You can set up automated reminders at 7, 14, and 21 days rather than waiting until payments are overdue.

• Use selective invoice financing: If you have a lot of outstanding invoices, selective invoice financing lets you choose which ones to finance based on the customer’s payment history and your cash flow needs. This flexibility can help smooth out the roughest parts of your cycle.

• Optimise your inventory: This takes more planning but can make a big difference. Just-in-time ordering reduces inventory days, but you’ll need reliable suppliers and accurate demand forecasting. Many UK businesses use a hybrid approach, keeping safety stock for the most critical items while running lean on predictable products.

• Manage supplier payments carefully: Extending payment terms can help your cycle, but damaging supplier relationships isn’t worth the short-term gain. So instead, consider negotiating volume discounts, then take advantage of them by paying earlier when your cash flow allows you to.

• Take a systematic approach: The most successful businesses track their cycle monthly, identify the biggest bottleneck, and focus on improving on that area before moving to the next one.

• Use trade finance strategically: Trade finance can provide the working capital you need to take advantage of bulk purchase discounts or early payment terms. But use it to improve your cycle rather than just to plug any gaps.

How does working capital cycle management support business growth?

If you want to grow your business predictably, you need to understand and actively manage your working capital cycle. Even the most promising of businesses can fail because they don’t anticipate how growth will impact their cash flow timing.

As your sales increase, every part of your working capital cycle becomes more impactful. For example, a 45-day cycle might be manageable at £10,000 in monthly revenue, but at £100,000, it could tie up £150,000 in financing. This scaling effect could catch your businesses off guard so try to keep an eye on it.

If you’re speaking with investors, bear in mind they’ll look beyond your revenue and will want to examine how efficiently you convert working capital into cash. If you can maintain or improve your cycle as you grow, you’ll stand out from competitors who only focus on sales.

Ultimately, your ability to grow sustainably depends on how quickly you turn working capital back into cash. If you can shorten your cycles while expanding, you’ll have a better chance of outperforming competitors that ignore this link.

You could also use revolving credit facilities such as a business line of credit to match financing with your cycle needs. Unlike fixed loans, revolving credit lets you borrow more during peak periods and pay back when things slow down, giving you the flexibility to grow without straining your cash flow.

Businesses that stick to spreadsheets and manual checks often struggle when growth accelerates. So try to avoid getting stuck in manual processes. Automated invoicing, inventory software, and payment tracking can become valuable tools as your transaction volumes grow.

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FAQs

How do I know if my working capital cycle is healthy?

Compare your cycle length to industry benchmarks and watch for month-on-month increases. A cycle that’s consistently growing or is a lot longer than competitors could suggest there are problems that need addressing.

How can I speed up my working capital cycle without hurting my business?

To improve cycles without damaging customer relationships, you could set up automated invoicing and payment reminders, offer small early payment discounts, and improve your inventory tracking.

How often should I monitor my working capital cycle?

Calculate your cycle each month and monitor trends over time. If you spot any major changes in any area (e.g. inventory, receivables, or payables), it’s worth investigating and potentially acting on.

How do I benchmark my working capital cycle against industry standards?

You could look at PwC’s Working Capital Study to compare your performance to the UK sector average. For example, professional services typically achieve 20-30 day cycles, and manufacturing often runs 60-90 days.

How can I present working capital cycle analysis to senior management in a compelling way?

Try focusing on the cash impact rather than just the numbers. For example, you could show how a 10-day cycle improvement could free up money to invest in growth or reduce borrowing costs.

What’s the difference between working capital cycle and cash conversion cycle?

The working capital cycle and the cash conversion cycle are similar but focus on different areas:

• Working capital cycle: Calculates how long it takes to turn your current assets into cash, covering everything from buying inventory to getting paid by customers and paying suppliers.

• Cash conversion cycle: Calculates the exact number of days it takes to convert inventory and receivables into cash, minus the time it takes to pay suppliers.

Both calculations use the same formula: Inventory Days + Receivable Days - Payable Days

Which working capital cycle metrics do investors focus on?

Investors typically prioritise the consistency and trends of your working capital cycle over current length. They want to see if you can maintain or improve efficiency during growth phases.

What systems should I put in place now to manage the working capital cycle as we scale?

You could implement automated invoicing, inventory management software, and customer payment tracking early as these systems will become valuable as transaction volumes grow.

How does rapid growth typically impact working capital cycle length?

Growth could initially extend your cycles as your business grows inventory and extends credit to new customers.

Can a negative working capital cycle be good for my business?

It could be, if it results from genuine efficiency rather than cash flow problems. For example, supermarkets achieve negative cycles by collecting customer payments before paying suppliers.

How does seasonality affect working capital cycles?

Seasonal businesses often need to extend their cycles during busy periods and shorten them during peak sales. It can be helpful to line up financing to support these natural variations rather than fighting them.

What financing options are suitable for different working capital cycle challenges?

Invoice finance can be used to deal with receivables challenges and working capital financing can provide general support.

Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.