Tag Archives | working capital

Operating Cycle Definition

See Also:
Operating Cycle Analysis

Operating Cycle Definition

The Operating cycle definition, also known as cash operating cycle or cash conversion cycle or asset conversion cycle, establishes how many days it takes for a company to turn purchases of inventory into cash receipts from its eventual sale. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days. These come together to form the complete measurement of operating cycle days. The operating cycle formula and operating cycle analysis stems logically from these. To be more specific, the payable turnover days are the period of time in which a company keeps track of how quickly they can pay off their financial obligations to suppliers. The next step, inventory turnover, is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, this ratio is calculated by taking the overall sales and dividing it by the overall inventory. However, the ratio can also be calculated by taking the cost of goods sold and dividing it by the average inventory. The final step, the accounts receivable turnover days, encase the period of time in which the company is evaluated on how fast they can receive payments for their sales. As said before, when all of these steps are put together the operating cycle is complete

Operating Cycle Applications

The operating cycle concept indicates a company’s true liquidity. By tracking the historical record of the operating cycle of a company and comparing it to its peer groups in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable since a company realizes its profits quickly and allows a company to quickly acquire cash that can be used for reinvestment. A long business operating cycle means it takes longer time for a company to turn purchases into cash through sales. In general, the shorter the cycle, the better a company is since less time capital is tied up in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. The easiest way to do this is to try to shorten each of the three cycle sections by, at least, a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle which can consequently lead to a more successful business.


Working Capital From Real Estate

See Also:
Balance Sheet
Current Assets
Current Liabilities
How to collect accounts receivable
Working Capital
Working Capital Analysis

An Asset Based Lending Solution to Cash Shortfalls and Opportunities


Many companies own the land and buildings necessary to conduct the day-to-day operations of their business. Oftentimes this valuable asset is included in traditional bank financing packages as the cornerstone of the credit facility. As long as the business progresses as the bank deems appropriate, and all loan and debt service coverage covenants remain in compliance, the real estate loan will serve to anchor the lending relationship.

Companies and/or individuals may also own commercial real estate which may provide an income stream or conversely, suffer from under-utilization and needed development. These transactions are typically financed by the banking community as a “onetime” advance which is conditioned for certain renewal requirements, and/or additional funding is triggered by developmental thresholds that have to be met. Additionally, the investment opportunity associated with these properties may require balance sheet leverage beyond what the bank is willing to tolerate.

More often than not, an adverse business or personal event occurs which places the commercial property owner in a position where cash is critical but not readily available. Such situations could involve delinquent taxes, tax liens, legal expenses, divorce settlements, environmental issues or any number of cash draining, unpleasant scenarios.

In the first two examples cited above, the traditional bank lending relationship may deteriorate because of economic or bank regulation issues beyond the control of the borrower. The real estate may have appreciated in value since the original bank loan was extended. However, further leverage of that equity is not available from the bank because of payment default, covenant compliance or regulation issues with which the bank has to contend. In the third example, the bank is oftentimes prohibited by internal policy and regulators from extending credit for the purpose of satisfying such obligations.


There are companies within the asset based lending community that can provide necessary funding to alleviate the cash shortfalls caused by the aforementioned problems. The asset based lender is more willing to look to the current appraised value of the real estate collateral to insure repayment as opposed to cash flow and financial statement strength. While loan to value percentages may be somewhat less than those allowed by the banking community, the liberal repayment terms and lack of covenant and compliance requirements afford the borrower the opportunity to alleviate the cash shortage and retain possession and control of the assets important to the well-being of the business and his livelihood. Bridge loans, interest only, twenty-five year amortizations, and escrowed payment reserves are some examples of the flexibility offered by an asset based real estate loan.

When cash is critical, and the options become limited, the appraisal value equity in commercial real estate can provide an asset based loan to alleviate the problem.

See related articles: Mining the Balance Sheet for Working Capital


Working Capital Analysis

See Also:
Balance Sheet
How to collect accounts receivable
Working Capital from Real Estate
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

Working Capital Definition

Working capital, also known as net working capital, indicates the total amount of liquid assets a company has available to run its business. In general, the more working capital, the less financial difficulties a company has.

Working Capital Formula

Working capital = Current assetsCurrent liabilities

Working Capital Calculation

Example: a company has $10,000 in current assets and $8,000 in current liabilities.

Working capital = 10,000 – 8,000 = 2,000


Working capital measures a company’s operation efficiency and short-term financial health. Positive working capital shows that a company has enough funds to meet its short-term liabilities. Negative working capital shows that a company has trouble in meeting its short-term liabilities with its current assets.

Working capital provides very important information about the financial condition of a company for both investors and managements. For investors, it helps them gauge the ability for a company to get through difficult financial periods. For management members, it helps them foresee any financial difficulties that may arise. It is very important for a company to keep enough working capital to handle any unpredictable difficulties.


Working Capital

See Also:
Balance Sheet
How to collect accounts receivable
Working Capital Analysis
Working Capital from Real Estate
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

What is Working Capital?

Formula: Current Assets – Current Liabilities = Working Capital

Working Capital is the difference between Current Assets versus Current Liabilities. (Current Assets are those assets that will be turned into cash within one year. Current Liabilities are those liabilities due within one year) This calculation represents the liquidity that a company has to meet its obligations coming due in the next 12 months. Though the amount should be positive, in times of distress it can be a negative amount.

Often as a management tool it is useful to track the change in working capital on a weekly basis. A company that is generating profits is usually increasing their working capital. Conversely, declining profits often consume working capital.

See Flash Report.


Mining the Balance Sheet for Working Capital

See Also:
Categories of Banks
Working Capital from Real Estate

Asset Based Lending Versus Commercial Bank Cash Flow Lending

Let’s face it; there has been significant liquidity in the marketplace over the past couple of years. Debt and equity capital has been relatively easy to find and commercial banks have been very willing participants as capital providers. However, many of the commercial banks have admitted that this robust marketplace is a prolonged cycle and not a permanent or semi-permanent marketplace shift. By definition as a cycle, what goes up must come down.

Already, many of the commercial banks are starting to whisper about declining portfolio quality and tighter credit standards. This has been attributed to issues regarding the sub prime mortgage market, rising energy costs, and other economic factors. These issues have resulted in some companies experiencing a weaker balance sheet and a decline in cash flow results.

As banks start to tighten their credit standards, many companies may find they have less access or no access to working capital from commercial banks. Banks may elect not to renew certain loans that come due. Also, companies that have tripped a covenant or are in a technical default may find that their commercial bank is not as patient and has asked that the loan be refinanced.

So how can a company still access adequate working capital in a changing bank marketplace? One way is to mine the balance sheet assets through an asset based, working capital line of credit.

Asset based lending is more common than ever and has become for many companies a more aggressive way to grow their business. Asset based lenders look beyond a company’s cash flow and balance sheet ratios to leverage the business assets for working capital purposes. Asset based lenders also provide an ease of doing business and typically have less restrictive operating covenants than commercial banks.

Commercial banks typically underwrite and grant credit by emphasizing in the following order:

1) Balance sheet strength/Cash flow

2) Management/Guarantors

3) Collateral/Assets

Asset based lenders assume there is some fundamental weakness to #1 above (at least by commercial bank standards) and flips the above equation upside down. The result is asset based lenders typically underwrite or grant credit by emphasizing in the following order:

1) Collateral/Assets

2) Management/Guarantors

3) Balance sheet strength/Cash flow

By emphasizing the value of a company’s assets as security and collateral for a working capital line of credit, an asset based lender has greater patience and tolerance for the bumps in the road and inconsistencies in the marketplace that many companies will face on a regular basis. Asset based lenders typically will provide a revolving line of credit against accounts receivables and inventory as collateral. Many asset based lenders will also provide term loans against equipment and possibly real estate.

Obviously, asset based lending is not the answer for every company’s need for working capital since not all companies generate these types of assets. Companies selling at retail or on cash terms don’t typically generate commercial accounts receivable which is the asset that most asset based lenders leverage as the base for a loan. However, if a company is involved in manufacturing, distribution and many of the service industries, chances are they would generate the types of assets favored by asset based lenders.

The benefit of this type of lending is that the loan availability can grow as a company’s assets grow and, therefore, is not as restrictive as traditional commercial bank cash flow lending; especially in rapid growth situations. Since asset based lenders rely primarily on the company’s collateral versus its cash flow results, they are able to embrace greater credit risk and accept inconsistent cash flow results versus commercial banks.

So as the marketplace changes and as commercial banks start to tighten up, remember that accessing adequate working capital may be as simple as mining the balance sheet through asset based lending.


Collect Accounts Receivable

See Also:
Accounts Receivable Collection Letter
Financial Ratios
Accounts Receivable Turnover
What is Factoring Receivables?
Net 30 Credit Terms
Accounts Receivable Collection Letter

Collect Accounts Receivable

Every company has them…past due and slow pay accounts. Here are some ways to help keep your cash coming in the door and collect accounts receivables.

Improve Accounts Receivable Collection and Invoicing

Commercial and industrial experience has proven the following percentages: Of ten new customers, six will pay on time, two will pay in 60 to 90 days and two will become collection problems.

Always watch your new sales. As money becomes tighter, you will receive one-time sales from firms that may be experiencing financial problems. These customers will bounce from business to business and need your close attention. A useful management tool for collecting accounts receivable is the Flash Report.

Be familiar with your customers’ credit. Only extend credit to organizations you feel confident will pay you. Make sure you don’t have to write off your hard earned sales through bad debt!

Pay close attention to the credit terms you are offering your customers. One good way to collect accounts receivable (ar) is to do so before you deliver your product and structure your terms accordingly. An example of this would be a propane company in the winter months; nothing works better than to be paid prior to delivery.

Examples of accounts receivable payment terms:

For custom manufacturing companies:

50% before work begins, 40% before delivery and 10% after delivery

For wholesalers and retailers:

Depending on creditworthiness, 10 days net for companies with good credit, prior to delivery for companies with questionable credit or those that are past due.

Develop a minimum sales order that will require a credit check

Check three references on a new client

If payment history is greater than 60 days obtain supervisor approval

The following steps should be preformed in invoicing the customer:
– invoice within 24 to 48 hours after performing service
– review invoices for accuracy
– make sure that everything has been billed
– note payment terms on the invoice

For more tips on how to optimize your accounts receivable, download your free A/R Checklist here.

Assign Responsibility for Accounts Receivable Collections

Use a dedicated collections individual. Designate one person in your organization to be the accounts receivable collections representative, someone who can make the collection calls and stay on top of accounts receivable. There are some personality traits that you should look for when assigning this function. Some traits to look for: A professional presence, adept at working with and handling difficult people, skilled at follow up and well organized in order to document collection efforts.

You may want to pay your accounts receivable collections individual a commission as an incentive to keep accounts receivable collections current. Alternatively, you might consider paying a bonus at certain increments based on established criteria.

The goal is to work with delinquent companies and receive payment as quickly and cost effectively as possible!

For many companies, accounts receivable collections may not be a full time commitment and may be added to a current employee’s responsibilities. If there is a legitimate reason the customer has not paid, it’s best to get this taken care of early so as not to impact your cash flow for any longer than necessary. Never underestimate the impact of reminder and collection calls!

Accounts Receivable (AR) Collection by Telephone

Given the use of voice mail the effectiveness of phone calls are somewhat diminished. However, they are still an effective means of collection. The phone calls enable the credit manager to present their case to the debtor for immediate response. During the conversation you can determine whether the claim will be paid in full and when. This is the time to determine the reasons for non-payment.

Three main reasons for non-payment
– Lack of funds. Most non-payments result from lack of funds.
– Dispute. Disputes can be discussed to determine whether or not they are valid. The valid claim must be adjusted quickly and fairly, the non-valid claim exposed and immediate payment requested.
– Refusal to pay. If it is refusal to pay, you must take third-party steps to enforce payment. Consider hiring a collections attorney.

Tips on phone collections
– Identify yourself and the company
– Call the person in charge
– Ask for the payment in full by a specific date
– If the bill is in dispute, suggest a solution
– Put it in writing if a solution is met
– Set up a personal meeting with the client if the solution is not met

Managing the Accounts Receivable Process

To quote Peter Drucker: You can’t manage it if you don’t measure it! The same holds true for collecting accounts receivable! So how do you measure your effectiveness in collecting accounts receivable?

Daily Sales Outstanding (DSO)

What is DSO? DSO is the average of your accounts receivable. The numerical accuracy of the number is not as important as the trend. It is intended to be a blended estimate of how long it takes to collect your accounts receivable. If you are making progress then it should be trending lower. The first thing you should do is calculate where you are today.

How do you calculate DSO?

DSO = 365/ (Annual Credit Sales/ Average Accounts Receivable)

Commercial Collection Servicies

Hire a collection agency. Ways to find a reputable collection agency include referrals from other companies as well as professional firms and organizations with which your company does business. No matter how you receive the referral, be sure to ask the collection agency for customer references and call the references. Some questions to ask: How responsive is the collection agency to your questions? Do you have a report on the progress of your accounts promptly and in a format that is user friendly? Do they remit proceeds quickly and accurately? Are issues resolved quickly?

Final Comments

Review your internal process. Collecting accounts receivable is an internal process as well! Before initiating collection calls, be sure your internal house is in order. It is vitally important that your cash applications are timely and done correctly. It’s extremely embarrassing and inefficient to have your collections representative make a collection call only to find that the customer has in fact paid the bill and the payment has been misapplied. A similar situation exists when a collection call is made and the payment was received 2 weeks earlier.

Accounts Receivable Collections

AR Collections should start with your cash applications function. Your process here is critical and must be followed without exception. Payments must be applied quickly and accurately. If a payment cannot be identified to an invoice, the customer MUST receive a timely phone call to identify what is being paid.

Make sure you issue invoices that make cash application quick and easy. Automation can be a big help when there are large volumes of invoices or you are short staffed. All systems should have an organized and mechanical follow up of accounts at regular intervals, for instance, 10,30 and 60 days past due.

Any program that permits three statements or a two to three month time lag before the first collection step is taken will result in a lower recovery ratio. Make collections update meetings a priority for the controller and collections person. At the meeting, collection notes, progress and next steps should be reviewed.

Know the Cost of Past Due Accounts

If you cover your cash shortfalls with a line of credit, consider that at an interest rate of 10% on your line, every $100,000 in past due accounts costs you $833 per month or $10,000 per year.

Train Your Customers to be Good Payers

Creating an accounts receivable collection process and following it consistently will allow you to accomplish this important goal.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

collect accounts receivable

Strategic CFO Lab Member Extra

Access your Cash Flow Tune-Up Tool Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

collect accounts receivable


Accounts Receivable Turnover Example

See Also:
Accounts Receivable Turnover Analysis

Accounts Receivable Turnover Formula Example

To emphasize it’s importance we will provide an accounts receivable turnover ratio example. Many companies live and die by collections. These rates are essential to having the necessary cash to cover expenses like inventory, payroll, warehousing, distribution, and more.

Manufactco is a company that manufactures widgets. Manufactco’s widgets have become very popular. The company is growing quickly and must hire new employees for their plant.

Annual Credit Sales: $10,000 Accounts Receivable in 1/1/09: $2,500 Accounts Receivable in 12/31/09: $1,500

Currently, Manufactco’s accounts receivable turnover rate is:

$10,000/ (($2,500 + $1,500)/2) = 5 times

Every company should have someone tasked as, amongst other bookkeeping matters, head accounts receivable turnover calculator. This person is known as a Chief Financial Officer (CFO). She has found that a full turnover happens 5 times in one year. To rephrase, in a full year all open accounts receivable are collected and closed 5 times. This is the accounts receivable turnover ratio meaning.

Now let’s make things a bit more complicated. How many accounts receivable turnover days will it take to complete one cycle?

Simply use this formula: Days Receivable Outstanding = # of days / accounts receivable ratio calculation

Many companies Google “accounts receivable turnover ratio calculator”, look towards their BA II, or scour their local bookstore. A properly trained CFO, however, has the answers to this and many other questions.

The period for this example begins at 1/1/09 and ends at 12/31/09. The number of days for this period, then, would be 365. Manufactco’s accounts receivable equation for the number of days a receivable is outstanding is:

365 days / 5 times = 73 days for AR to turnover

This means that all open accounts receivable are collected and closed every 73 days. In 73 days customers make a purchase, are reminded that payment is due, send payment, have payments processed, and have receivable accounts closed.

The Chief Financial Officer of Manufactco now knows that 5 full turnovers happen in a year. She also knows that it takes 73 days for one full turnover to occur. Creating a profitable company is now a simple matter.

Tightening credit policies is one common method. Options include decreasing the amount of days allotted before payment is due, including or increasing discounts for early payment, or increasing the late payment penalty fee. Additionally, she could update collections technologies or simply increase collections staff. In extreme conditions Manufactco could even stop serving certain customers, in effect “firing” those who are late or non-paying. All of these tools are available for the clever CFO.


 Download Free Whitepaper Today!