Understanding the Working Capital Optimization Cycle

Having less cash tied up in receivables, payables and inventory means having more cash available for paying down debt or investing in your business.

Executive Summary with Jason Sweatt, Liquidity and Deposits Group Manager

The working capital optimization, or cash conversion, cycle allows you to look at these three areas to determine where your cash is tied up, says Jason Sweatt, vice president and liquidity and deposits group manager at Regions Bank.

Sweatt recently shared his thoughts about the cycle and what it means for your business.

What is the working capital optimization cycle?

The working capital optimization cycle is a way of looking at a company’s receivables, payables and inventory and at how it handles those on a day-to-day basis.

The cycle provides a look at how much working capital it takes to run your business.

There are three aspects: receivables, payables and inventory. A receivables perspective shows how many days it takes to get paid. A payables perspective shows how long it takes to pay your vendors. An inventory perspective shows you how long it takes to turn over your inventory.

How do you calculate the working capital optimization cycle?

To calculate receivables, multiply your sales by 365 days and divide that from your accounts receivables. That will give you your days sales outstanding.

To calculate payables, multiply cost of goods sold by 365 days and divide that from your accounts payable. That will give you your days payable outstanding.

To calculate your inventory, multiply your cost of goods sold by 365 days and divide that from your inventory cost. That will give you your days inventory outstanding.

The working capital optimization cycle equals days sales outstanding plus days inventory outstanding minus days payable outstanding.

This number will vary depending on your individual business and industry. However, businesses should look at their working capital optimization cycle year over year to see how they're performing and compare themselves to their peers. The information for publicly traded companies is available online to use as a benchmark.

How can a business manage these three aspects to increase cash flow?

You want to get receivables in as fast as possible, and you do that by having the right mix of treasury management services, such as by having your clients pay you by automated clearing house or wire. You can also offer a discount for clients who pay quickly.

On the payables side, you want to delay payment to vendors as long as possible, unless there’s a discount for early payment that you can take advantage of. You want to hang on to your cash as long as you can so you can use it to pay down your debt or invest.

The inventory side varies depending on the business, but each business needs to manage its inventory — lean manufacturing and just-in-time supplies are two popular inventory techniques.

How can a business shorten its working capital optimization cycle?

Businesses need to utilize the right mix of treasury management products. Taking checks to the bank yourself takes time, but a product such as quick deposit allows you to deposit checks directly from your desk.

You can also use a lockbox, which speeds up the deposit process and provides access to funds a few days sooner than if you had taken the money to the bank.

Businesses such as gas stations, which go through a lot of cash, may want to use an electronic vault service in which cashiers deposit money into a vault that sends a feed to the bank telling it the amount. This provides immediate access to funds.

Why is understanding the working capital optimization cycle so important?

It allows you to make more money, which is done through either paying down debt such as a line of credit, or being able to invest funds quicker so you have a rate of return on your cash instead of it sitting there in the cycle.

For example, Regions Bank calculated the working capital optimization cycle of a client and noticed that from 2011 to 2012, the company’s receivables slowed by 10 days. The client said it was the nature of his business with today’s economy, and his receivable contracts had increased to 60 days net pay.

Regions suggested the business convert its checks to automated clearing house, which would save it an average of $2.13 to process each check, saving more than $500 a month. The automated clearing house process also shortened the working capital optimization cycle by delivering funds quicker and providing access sooner.


This information is general in nature and is provided for educational purposes only. Regions makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information presented. Information provided and statements made by employees of Regions should not be relied on or interpreted as accounting, financial planning, investment, legal, or tax advice. Regions encourages you to consult a professional for advice applicable to your specific situation.