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How to Free Up Working Capital By Managing the Cash Cycle

By: Eric Giltner
Senior Area Manager
Grand Forks Area Office
North Dakota District Office

Your business adds value to inputs (raw materials, information, inventory) and sells them for a profit as products and services. To do this, you must fund both the purchase of inputs and the activity of adding value. The money used for this is working capital. Working capital is generally defined as capital assets easily converted to cash.

The lament of many business owners is “If I just had a little more working capital, I could generate some nice profits!” Most lenders are willing to provide working capital if they believe that you can manage the working capital cash cycle. The cash cycle refers to the continual flow of resources into and out of working capital accounts. These accounts are cash, accounts payable, accounts receivable, inventory, and accruals.

The problem with obtaining more working capital is the cost of paying for it. A better idea would be to manage working capital needs carefully and use debt sparingly. There are three main areas to focus on: accounts receivable, accounts payable, and inventory usage.

Accounts Receivable
When you sell your products and services on credit you become, in effect, a lender. It is important that you properly manage this activity. A sale is not successful until you receive an acceptable amount of cash. To ensure this collection of cash, you must first decide which customers can buy on credit. The six “C’s” of banking - Character, Cash, Collateral, Capacity to pay, Credit, and Conditions – are commonly used to make this decision. You will then need to establish credit terms. Credit terms include when and how payments should be made; incentives to encourage early payment; and what you will charge for late fees. You should seek advice from an accountant when setting up these policies.

Inventory Management
Inventory acts as a buffer against shortages in any point of the value added process. The fear of losing  a sale causes many businesses to overstock inventory and materials. The costs of holding too much inventory are real but not always evident. These include costs of management and handling, security systems, obsolescence, theft, insurance, deterioration, and storage. To reduce these costs, consider a demand management system for customer orders and a just-in-time system for delivery of inventory from suppliers.

Managing Payables
You should buy inventory and raw materials using the best or longest terms of credit possible. Again, credit decisions are based upon the six “C’s” of banking discussed above, and you should make sure that you are credit-worthy in the eyes of your suppliers. View payables as a source of interest-free financing. Don’t pay before the date specified by the terms unless there is a discount for early payment. Then consider whether the discount is enough to offset the disadvantage of paying early.

In summary, you should be less concerned with obtaining more working capital. Instead, invest time and effort into managing the beast that consumes working capital - the cash cycle!


Eric GiltnerEric Giltner has been a Business Development Specialist and the Grand Forks area manager for the U.S. Small Business Administration since 1998, having formerly been assistant to the dean of the UND College of Business and Public Administration.  He received his B.S. Degree in Geological Engineering and his Master's Degree in Business Administration from the University of North Dakota. Eric can be reached at eric.giltner@sba.gov.