Working Capital: Inventory, Customers and Suppliers

How the money tied up in stock, unpaid customer bills and supplier credit affects a company's cash, and how businesses manage it.

Running a business ties up money in day-to-day operations. A shop must buy stock before selling it. A manufacturer may wait months to be paid by customers. At the same time, suppliers may give the business time to pay. The money tied up in this cycle is called working capital.

The main parts

Working capital is usually measured as current assets minus current liabilities. The key operating items are:

Inventory: goods waiting to be sold, or materials waiting to be used.
Accounts receivable: money customers owe for goods already delivered.
Accounts payable: money the business owes its suppliers.

Inventory and receivables tie up cash. Payables free it, because the business holds on to cash until the supplier bill is due.

The cash conversion cycle

Businesses track how long cash is tied up using the cash conversion cycle: the number of days to sell inventory, plus the days to collect payment from customers, minus the days the business takes to pay its suppliers. A shorter cycle means less cash is locked up.

A tale of two retailers

A furniture store holds stock for 90 days and gives customers 30 days to pay, while paying suppliers within 30 days. Its cash is tied up for 90 days. A supermarket sells food within about two weeks, is paid immediately at the till, and pays suppliers after 30 days. Its cycle can be negative: it collects cash from customers before paying for the goods. That gives it free cash to use in the meantime.

Managing it

Companies improve working capital by holding less inventory, collecting from customers faster and negotiating longer payment terms with suppliers. Techniques like just-in-time production, made famous by Toyota, keep inventory low by receiving parts only as they are needed.

But pushing too hard has costs. Too little inventory risks running out when demand rises or supply chains are disrupted, as many firms found during the COVID-19 pandemic. Delaying payments to suppliers can strain small suppliers who rely on being paid promptly, which is why some governments set limits on payment delays.

Thinking more sales always means more cash

Growing sales often requires more inventory and creates more unpaid customer bills, both of which absorb cash. A company that grows quickly can run short of cash unless it manages working capital carefully or arranges financing.

Key takeaways

Working capital is money tied up in day-to-day operations.
Inventory and customer receivables tie up cash; supplier payables free it.
The cash conversion cycle measures how long cash is locked up.
Lean inventory and fast collection help, but going too far brings risks.