What is working capital, really?
Working capital is the money tied up in running the business day to day: stock on the shelves or in the warehouse, plus invoices customers haven’t paid, minus bills you haven’t paid yet. It isn’t profit, and it isn’t the balance in your bank account. It’s the cash your business has lent to its own trading.
The working capital cycle measures how long that money stays tied up — and so how much cash the business needs just to keep trading at its current size.
Which three numbers make up the cycle?
Stock days
How long stock sits before it’s sold.
Stock days = (average stock ÷ annual cost of sales) × 365
Debtor days
How long customers take to pay after you invoice.
Debtor days = (trade debtors ÷ annual credit sales) × 365
Creditor days
How long you take to pay suppliers.
Creditor days = (trade creditors ÷ annual purchases) × 365
Putting them together
Working capital cycle = stock days + debtor days − creditor days
How does it work in practice?
Example scenario — illustrative only. A Melbourne homewares importer brings in containers through the Port of Melbourne and sells to independent retailers on 30-day end-of-month terms. Its figures:
| Measure | Figure |
|---|---|
| Average stock on hand | $420,000 |
| Annual cost of sales | $1,825,000 |
| Trade debtors | $260,000 |
| Annual credit sales | $2,600,000 |
| Trade creditors | $200,000 |
| Annual purchases | $1,825,000 |
- Stock days = (420,000 ÷ 1,825,000) × 365 = 84 days
- Debtor days = (260,000 ÷ 2,600,000) × 365 = about 37 days
- Creditor days = (200,000 ÷ 1,825,000) × 365 = 40 days
Cycle = 84 + 37 − 40 = about 81 days.
Cost of sales runs at roughly $5,000 a day, so about 81 days of it — in the order of $400,000 — is permanently funding the trading cycle. That’s cash the owner can’t use for anything else.
It’s worth noticing what 30-day end-of-month terms mean in practice. An invoice dated 2 March isn’t due until 30 April, so even customers who pay on time take close to two months on invoices raised early in the month. That’s partly why this importer’s debtor days sit well above 30.
What does the cycle tell you?
- How much funding trading needs. Daily cost of sales multiplied by cycle days gives a rough measure of the cash tied up.
- Where to focus first. If stock days are the biggest number, look at purchasing and slow lines. If debtor days are, look at invoicing and collections.
- What growth will cost. If sales rise by a third and the cycle stays at 81 days, the cash tied up rises by roughly a third too — before any new staff or premises.
What’s typical for different industries?
Patterns vary widely, but as a general guide:
| Industry | Typical pattern |
|---|---|
| Cafés and restaurants | Short or negative — customers pay at the counter |
| Retail | Stock days dominate, especially in the lead-up to Christmas |
| Wholesale and importing | Long stock days, plus trade terms to customers |
| Construction and trades | Debtor days and retentions dominate |
| Professional services | Work in progress and debtor days dominate |
| Horticulture and viticulture | Very long — costs run a season ahead of payment |
| Transport and freight | Short stock days, but long customer payment terms |
Seven ways to shorten the cycle
- Clear slow stock. Review lines quarterly and move on anything that isn’t turning.
- Order smaller and more often where suppliers and freight costs allow.
- Invoice the same day work is finished or goods are dispatched.
- Tighten collections — reminders before the due date, a phone call on the first day overdue. See debtor days and payment claims.
- Take deposits on custom or large orders.
- Negotiate supplier terms that line up with when you’re paid — see negotiating supplier terms.
- Look at when GST on imports is paid. GST on imported goods is normally paid before the goods are released. Importers that are registered for GST and report monthly may be able to apply for the ATO’s deferred GST scheme, which moves that payment onto the monthly BAS. Ask your accountant whether it suits you.
Taking even ten days off the cycle can free a meaningful amount of cash.
Why measure seasonal businesses month by month?
Annual averages hide peaks. A retailer’s stock days in October, with Black Friday and Christmas stock landed but not yet sold, can be double its annual figure. A wine grape grower’s cycle barely makes sense on an annual basis at all. Work out the cycle for your peak months separately — that’s when the funding need is highest. Our seasonal cash flow plan shows how to build it into a 12-month view.
What mistakes distort the measurement?
- Using year-end balances only. If 30 June falls in your quiet season, stock and debtors will look unusually low.
- Mixing cash and credit sales. Debtor days should be based on credit sales; including cash sales makes them look shorter than they are.
- Leaving out work in progress. Trades, manufacturers and professional firms often carry large amounts of unbilled work. Treat it like stock that hasn’t been sold.
- Ignoring landed costs. Freight, customs duty, port charges and GST on imports are paid up front and lengthen the real cash gap.
- Measuring once a year. Customers, suppliers and seasons change. Recalculate at least quarterly.
How is the remaining gap usually funded?
Once you’ve shortened the cycle as far as is practical, what’s left needs funding. Because the cycle repeats, a revolving facility is usually the natural fit: draw to pay for stock or wages, repay as customers pay, and draw again for the next turn. Unsecured lines of credit generally suit businesses trading six months or more, with limits based on turnover and business bank statements.
For a bigger step up — a major new customer, a large indent order or a new product range — a property-secured top-up of $20,000 to $1m can sit alongside a revolving line as a lump sum. Our 60-second enquiry is free and doesn’t affect your credit score. To see how a facility can fund each turn of the cycle, read about revolving business credit.