The importance of the Working Capital Cycle (WCC)

Your Working Capital Cycle (WCC) is how long it takes to turn your net current assets and current liabilities into cash. Put another way, it’s a measure of the time from buying raw materials to getting paid for finished products.

The shorter the period, the better your financial position. If the WCC is too long, your capital gets tied up for an extended period, meaning you may not have the cash on hand to pay your bills.

Let’s demonstrate the point with an example. A company might buy goods on 30 days’ credit; we then need to know how long it takes to convert these goods into cash in the bank.

If we know that the company has average sales of £20,000 and an average stock holding of £5,000, the calculation would be 5,000 / 20,000 x 365, giving us 91.25 days.

However, that’s when the company makes the sale, not when it gets paid. To find this figure, we need to do another calculation. If the company has outstanding debts of £6,000 and total credit sales amounting to £40,000, its average collection period is 6,000 / 40,000 x 365 or 55 days.

Adding these figures together, we now know that the company has to pay its creditors in 30 days but does not get paid for 146 days. That’s more than four months, creating a cash flow void of 116 days.

So, what can the business do to shorten its Working Capital Cycle?

Shortening the Working Capital Cycle

One easy step is to encourage customers to pay faster, either by changing terms of business or stepping up collections activity. (Another approach could be to offer a small discount for payment within a week as some creditors respond very well to this.)

More importantly, the company can look to streamline its manufacturing process. Should it really take three months to convert materials into finished products before marketing them?

This is something over which the company has significant control: although certain processes cannot be shortened, there is no excuse for leaving capital tied up in stock any longer than necessary. But if these steps don’t eliminate the lacuna (and they probably won’t), the company will need capital finance.

Obtaining short-term capital finance

There are a number of different ways that you can finance cash flow shortfalls. You could take a structured working capital loan, intended to be paid back over a few months, but this won’t solve ongoing problems. An overdraft or a line of credit will provide an ongoing solution, but banks are cautious about offering the former and the latter can be quite expensive (though you only pay interest when you’re actually using the flexible facility to borrow).

Finally, invoice factoring or discounting can tame a troublesome cash flow for good: these innovative solutions allow you to borrow against your invoices as soon as you issue them, meaning you effectively get paid immediately.

With factoring, the finance company will assign experienced credit control professionals to secure early payment, thus quickly repaying your debt, whilst with invoice discounting you retain control of your own debtor ledger.



Login/Register access is temporary disabled