Working Capital Cycle
The working capital cycle (also called the cash conversion cycle) is the time it takes for a company to convert its investments in inventory and other resources into cash received from customers. A shorter cycle means faster cash generation; a longer cycle ties up more cash in operations.
What Is the Working Capital Cycle?
Working Capital Cycle = DIO + DSO – DPO
Where:
– **DIO (Days Inventory Outstanding)**: how long inventory is held before being sold
– **DSO (Days Sales Outstanding)**: how long it takes to collect cash from customers after a sale
– **DPO (Days Payables Outstanding)**: how long the company takes to pay its suppliers
A positive cycle means cash is tied up for that many days. A negative cycle (like Amazon or supermarkets) means the company collects from customers before it pays suppliers.
Practical Significance
Companies with long working capital cycles need more cash (or credit facilities) to fund operations. Companies with short or negative cycles are self-funding and can grow without much external capital.
Working Capital and Cash Flow
Even a profitable company can face cash flow problems if its working capital cycle is too long. For example, a company selling on 90-day credit terms may show profit in the P&L but struggle to pay salaries while waiting for customer payments.
Industry Comparison
| Industry | Typical Cycle |
|———|————-|
| Supermarkets | Negative (collect before paying) |
| Manufacturing | 60-120 days |
| Infrastructure | 180-360 days |
| IT services | 30-60 days |
Practical Example
A manufacturer has:
– DIO = 60 days (holds inventory 2 months)
– DSO = 45 days (collects receivables in 45 days)
– DPO = 30 days (pays suppliers in 30 days)
Working Capital Cycle = 60 + 45 – 30 = 75 days
The company needs 75 days of operating expenses funded at all times. If annual COGS is Rs 365 crore, it needs approximately Rs 75 crore of working capital financing.
Key Takeaways
– Working capital cycle = DIO + DSO – DPO; measures days of cash tied up in operations
– Shorter cycle means less working capital needed and faster cash conversion
– Negative cycles (supermarkets, SaaS) are a competitive advantage: business is self-financing
– Improving the cycle (collecting faster, holding less inventory, paying suppliers slower) reduces working capital needs
– Working capital management is critical for manufacturing, trading, and project-based businesses
