ZZetaCracked
Sign in
Chapter 4 of 5 · 10 min

Working capital as a cash lever

Collect faster, hold less stock, pay suppliers later: cash comes out once, without touching EBITDA.

By the end of this chapter you can
  • Calculate receivables, inventory, payables and net working capital from days
  • Calculate the cash conversion cycle
  • Work out the cash released by cutting DSO or stretching DPO
  • Find the days of DSO to cut for a cash target
1

The intuition

A bakery buys flour, keeps a week's worth on the shelf, bakes, and sells to cafés that pay a month later, while the miller wants paying in two weeks. The baker's own money fills the gap. If the cafés paid in two weeks instead, the baker would suddenly have two weeks of sales sitting in the bank, once, without baking a single extra loaf.

That gap is working capital. Each day customers take to pay (DSO) and each day of stock on hand (DIO) ties up cash; each day the company takes to pay suppliers (DPO) frees it.

The key idea

Receivables = DSO × revenue ÷ 365. Inventory = DIO × COGS ÷ 365. Payables = DPO × COGS ÷ 365. Net working capital = receivables + inventory − payables. Cash conversion cycle = DSO + DIO − DPO.

2

Why it works

  • The conventions here: a 365-day year. Receivables are measured in days of revenue; inventory and payables in days of cost of goods sold (COGS). Cash released by a change in days is released once, at today's revenue and COGS.
  • One day of DSO is worth a day of revenue; one day of DPO or DIO is worth a day of COGS, which is smaller. So a day of collections is worth more than a day of supplier terms.
  • The cash comes out once. The balance steps down and stays down. After that, working capital only grows with revenue.
  • EBITDA does not change. The benefit is cash, which repays debt, not earnings.
  • Why sponsors pull it first: it needs no new customers, can be done in months, and every dollar goes straight to debt paydown.
  • The trap is doing it too hard. Starve inventory and you miss sales; squeeze suppliers and they price it back in or cut you off in a downturn.
Revenue $365M, COGS 60% ($219M); DSO 50, DIO 60, DPO 40
Receivables: 50 × 365 ÷ 36550.0
Inventory: 60 × 219 ÷ 36536.0
Payables: 40 × 219 ÷ 36524.0
Net working capital: 50 + 36 − 2462.0
Cash conversion cycle: 50 + 60 − 4070 days
Cut DSO 10 days: 10 × 1.0; stretch DPO 10 days: 10 × 0.610.0 against 6.0

Days of DPO to match the 10-day DSO cut: 10 ÷ 0.6 = 16.7. For $15M from receivables: 15 days.

3

The formulas

Receivables = DSO × revenue ÷ 365

Days of sales not yet collected.

Inventory = DIO × COGS ÷ 365; payables = DPO × COGS ÷ 365

Days of cost on the shelf, and not yet paid.

Net working capital = receivables + inventory − payables

Cash tied up in running the business.

Cash conversion cycle = DSO + DIO − DPO

Days between paying suppliers and being paid.

Cash from cutting DSO by d days = d × revenue ÷ 365

A day of revenue per day cut.

Days of DSO to cut for a cash target = target × 365 ÷ revenue

Run it backwards.

4

Worked example

Turn each day count into dollars, receivables off revenue and the other two off COGS, then add and subtract.

Drawing the numbers…
5

See it move

Same company. Change the three day counts, COGS as a share of revenue, and the size of a DSO cut and a DPO stretch.

Drawing the numbers…
Try this
  • Raise DSO. Receivables and the cycle grow, but the cash released by a given DSO cut does not change.
  • Raise DPO. Payables grow, so net working capital and the cycle shrink.
  • Raise COGS as a share of revenue. A day of DPO is worth more, so fewer days of stretch match the DSO cut.
  • Raise the DSO cut. More cash is released, and it takes more days of DPO stretch to match it.
6

Run it backwards

Same company, reversed: the sponsor wants a set amount of cash out of receivables in year one. How many days must collections improve?

Drawing the numbers…

Each day of DSO is a day of revenue, revenue ÷ 365. Divide the cash target by it for the days, and subtract from today's DSO for the new target.

A single-digit cut is usually process: invoicing on time and chasing overdue accounts. Much more means renegotiating terms with customers, which has a cost the cash number hides.

7

Traps

Measuring inventory and payables off revenue.
They are days of COGS. Only receivables use revenue.
Treating released cash as recurring.
It comes out once, when the balance steps down.
Adding released cash to EBITDA.
Working capital moves cash flow, not earnings.
Treating a day of DPO like a day of DSO.
A day of DPO is worth COGS ÷ 365, less than a day of revenue.
Squeezing suppliers first.
Collecting what customers owe upsets nobody; stretching suppliers is borrowing from them, and they price it back in.
8

Say it in the interview

The interviewer asks

“How can a sponsor generate cash from working capital?”

Say yours out loud first, then compare.
9

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4
Drawing your questions…
Remember
  • NWC = receivables + inventory − payables.
  • Cycle = DSO + DIO − DPO.
  • A day of DSO releases revenue ÷ 365; a day of DPO, COGS ÷ 365.
  • The cash comes out once, and EBITDA does not move.