Working capital cycle
The working capital cycle is the time between paying for inventory or labour and collecting cash from the customer — inventory days plus receivable days, minus the days suppliers give you to pay. A longer cycle means more cash is tied up running the business day to day, which is what a working capital peg in a purchase agreement is meant to cover.
Every business that carries inventory or bills after delivery has cash locked up between spending it and getting it back. A contractor who buys materials, does the work, and invoices net-30 might wait sixty or ninety days to see that cash again. A retailer holding six months of stock has a different but related problem. The cycle is what ties earnings on paper to cash in the bank.
The three pieces
- Days inventory is held before it sells
- Days it takes to collect from customers after the sale
- Days suppliers give the business to pay for what it bought
Why a buyer needs to understand it before closing
A business with a long cycle needs more working capital to run at the same sales level than one that collects fast and pays slow. A buyer financing the purchase has to fund that gap on top of the purchase price, which is exactly what the working capital peg in the purchase agreement is negotiated to address.
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01Treadstone LawLegal commentaryHow to Read a Business's Financial Statements Before You Buy in Ontario
- 02Treadstone LawLegal commentaryInventory Count and Valuation on Closing Day in an Ontario Business Sale
- 03Business Development Bank of CanadaIndustryHow to sell your business
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