What is working capital?
Working capital is the money tied up in running the business day to day: stock on the shelves, invoices customers haven’t paid, minus bills you haven’t paid yet. It’s not profit, and it’s not the cash in the bank. It’s the cash your business has lent to its own trading.
The working capital cycle measures how long that money is tied up.
The three numbers
Stock days
How long stock sits before it’s sold.
Stock days = (average stock ÷ cost of sales) × 365
Debtor days
How long customers take to pay after you invoice.
Debtor days = (trade debtors ÷ credit sales) × 365
Creditor days
How long you take to pay suppliers.
Creditor days = (trade creditors ÷ purchases) × 365
The cycle
Working capital cycle = stock days + debtor days − creditor days
A worked example
Example scenario — illustrative only. An Auckland kitchenware wholesaler has:
| Measure | Figure |
|---|---|
| Average stock | $300,000 |
| Annual cost of sales | $1,460,000 |
| Trade debtors | $250,000 |
| Annual credit sales | $2,000,000 |
| Trade creditors | $120,000 |
| Annual purchases | $1,460,000 |
- Stock days = (300,000 ÷ 1,460,000) × 365 = 75 days
- Debtor days = (250,000 ÷ 2,000,000) × 365 = 46 days
- Creditor days = (120,000 ÷ 1,460,000) × 365 = 30 days
Cycle = 75 + 46 − 30 = 91 days.
For three months, on average, the business has paid for stock that hasn’t yet turned into cash. At roughly $4,000 of cost of sales a day, that’s a lot of money funding the trading cycle.
What the cycle tells you
- How much funding you need. Multiply daily costs by cycle days for a rough idea of working capital tied up.
- Where to focus. If stock days are the biggest number, look at inventory. If debtor days are, look at collections.
- What growth will cost. If sales grow 30% and the cycle stays at 91 days, the working capital tied up grows roughly 30% too.
Typical cycles by industry
These vary widely, but as a general guide:
| Industry | Typical pattern |
|---|---|
| Cafés and restaurants | Short or negative — customers pay immediately |
| Retail | Stock days dominate, especially before peak season |
| Wholesale and import | Long stock days plus customer terms |
| Construction and trades | Debtor days and retentions dominate |
| Professional services | Work-in-progress and debtor days dominate |
| Horticulture | Very long — costs a season ahead of returns |
Seven ways to shorten the cycle
- Cut slow-moving stock. Review lines quarterly and clear anything that isn’t turning.
- Order smaller, more often where suppliers allow.
- Invoice faster. Same-day invoicing can remove days from debtor days immediately.
- Tighten collections. Reminders before due dates, calls on day one of overdue.
- Take deposits on custom or large orders.
- Negotiate supplier terms — see negotiating supplier terms.
- Use the GST payments basis if eligible and customers pay slowly — see GST timing.
Even shaving ten days off the cycle can free up meaningful cash in a business of any size.
Seasonal businesses: measure by month
Annual averages hide seasonal peaks. A retailer’s stock days in October can be double its annual average. Calculate the cycle for your peak months separately — that’s when your funding need is highest.
Common mistakes when measuring the cycle
A few errors make the working capital cycle look better or worse than it really is:
- Using year-end balances only. If your balance date falls in a quiet month, stock and debtors may look unusually low. Average several points in the year instead.
- Mixing cash and credit sales. Debtor days should be based on credit sales; including cash sales understates them.
- Forgetting work in progress. Trades, manufacturers and professional firms often carry significant unbilled work. Treat it like stock that hasn’t been sold yet.
- Ignoring GST and freight on imports. These are paid upfront too and lengthen the real cash gap.
- Measuring once. The cycle moves as customers, suppliers and seasons change. Recalculate at least quarterly.
Getting the measurement right matters, because the cycle is the number that tells you how much funding is genuinely needed — not just how much would be nice to have.
Funding the cycle
Once you’ve shortened the cycle as far as practical, what’s left needs funding. Because the cycle repeats, revolving credit is usually the right fit:
- A revolving line of credit funds each turn of the cycle and refills as customers pay. It generally suits businesses trading six months or more, with limits based on turnover and bank statements.
- For a larger step-up — a major new contract or a big stock build — a property-secured loan of $20,000 to $1m can sit alongside the line.
Put it in your forecast
Knowing your cycle makes your cash flow forecast more accurate: you know how long after a sale the cash arrives, and how long before it the costs go out. Our seasonal cash flow plan guide shows how to build that into a twelve-month view.