Why Profitable Departments Run Out of Cash: Working Capital for Managers

The classic example: profitable but broke

A growing business takes on a R10m order. To fulfil it, they buy R6m of stock on 30-day credit terms. They incur R2m of additional labour and overhead, paid weekly. They ship the order and invoice the customer on 60-day terms.

By the time the customer pays — 60 days after delivery, plus the time taken to deliver — the business has been funding the labour, the overhead, and the stock for over 90 days. The supplier’s credit has only covered 30 days of that.

The business is profitable on the order: revenue exceeds cost. But it’s been funding R8m of net working capital for the better part of three months. If it doesn’t have access to that cash — through retained earnings, an overdraft, or external finance — it runs out of money before the customer pays.

This is the working-capital trap. Growth absorbs cash before it generates it. Profitable businesses go bust by growing too fast — not because the unit economics are bad, but because the cash timing doesn’t work.

For operational managers, the takeaway isn’t “watch out for growth.” It’s that the levers that determine the trap’s severity — stock holding, customer credit, supplier credit — are mostly under operational control, not financial control.

What working capital actually is

The JSF course manual’s definition: working capital is the capital required for the day-to-day running of the business — the money needed to buy stock, finance debtors (customers who owe), pay creditors (suppliers waiting to be paid), and cover daily running expenses.

The formula taught in the course:

Stock + Debtors − Creditors = Net Working Capital

Equivalently: stock you’ve bought but haven’t sold + sales you’ve made but haven’t been paid for − purchases you’ve made but haven’t paid for. The first two are cash tied up; the third is cash you’re borrowing from suppliers, in effect.

A second framing from the course: “the money tied up in stocks and debtors less the amount financed by creditors.” Same idea, plainer English.

A business’s working capital position is a snapshot at a point in time. It moves continuously as stock comes in, customers pay, and bills go out.

Why operational managers control more of it than they realise

This is the most consistently missed point in finance training for managers. Working capital isn’t a finance-team decision — it’s the cumulative result of operational decisions made every day, mostly by people who don’t realise they’re making working-capital decisions.

Inventory levels. Every “let’s keep more stock on hand” decision is a working-capital decision. The cost isn’t just storage; it’s the cash tied up.

Customer credit terms. Sales teams negotiating “let’s give them 60 days” to win an order are making a working-capital decision — sometimes a much larger one than they realise. The same order on 30-day terms vs 60-day terms is the same revenue, with a R-millions-different cash impact at scale.

Supplier terms. Operations teams accepting 14-day payment terms when 30-day was available are giving up working-capital benefit. Procurement teams negotiating extended terms are gaining working-capital benefit.

Stock-out tolerance. Departments that hold buffer stock “just in case” are funding the buffer with the company’s cash.

A capable operational manager understands that each of these is a trade-off. Faster customer payment terms might cost a discount. Extended supplier terms might cost a premium. Lower stock levels might cost an occasional stock-out. The working capital impact is one factor among several — but it’s a factor most managers don’t quantify.

The cash conversion cycle

The most useful working-capital metric for operational managers. It answers: how many days is cash tied up in the operating cycle?

The cycle:

Days inventory + Days sales outstanding − Days payable outstanding = Cash conversion cycle

Where:

• Days inventory — average days a stock item sits on the shelf before being sold
• Days sales outstanding (DSO) — average days a sales invoice waits before being paid
• Days payable outstanding (DPO) — average days the business takes to pay suppliers

If the cycle is positive (e.g. 45 days), cash is tied up in the operating cycle for 45 days. If negative (some businesses with very fast inventory turnover and slow supplier payment — large retailers, some service businesses), the business is effectively running on customer or supplier cash.

The operational lever: any reduction in days inventory, any reduction in DSO, or any increase in DPO reduces the cycle and frees cash. Material reductions — even a few days — translate to material cash freed up.

Three ratios worth knowing

Current ratio = Current Assets ÷ Current Liabilities. The basic liquidity test. Above 1 means the business could in principle pay all short-term debts from short-term assets. Above 1.5 is generally comfortable; below 1 is a warning.

Acid test ratio = (Current Assets − Stock) ÷ Current Liabilities. The same calculation excluding stock — on the basis that stock can’t always be sold quickly to pay debts. More useful in seasonal businesses where stock builds up at certain times. A current ratio of 2 might hide an acid test ratio of 0.7 if most of the current assets are slow-moving stock.

Working capital ratio = Stock + Debtors − Creditors. The operational measure (different from the finance-textbook “working capital ratio” which is sometimes used to mean the current ratio). This is what the JSF course teaches as the practical management figure.

For an operational manager, the working-capital ratio in absolute terms (the rand figure) is what to track. The current and acid test ratios are what the CFO will quote in a board context. Knowing both registers makes the conversation more efficient.

The levers — and the trade-offs

Each working-capital lever has a cost as well as a benefit.

Shorten DSO (collect from customers faster). Reduces working capital. Costs: customer relationship friction, potential discount for early payment, lost sales if terms are tightened too aggressively.

Lengthen DPO (pay suppliers later). Reduces working capital. Costs: supplier relationship friction, potential loss of early-payment discounts, possible price increases on next renegotiation.

Reduce days inventory (hold less stock). Reduces working capital. Costs: occasional stock-outs, expedited freight, potential customer-service impact.

Shift to consignment stock or just-in-time models. Can radically reduce working capital. Costs: supplier dependency, vulnerability to supply chain disruption.

The point isn’t that any of these is wrong. The point is that the trade-off should be deliberate. A working-capital improvement that costs more in customer relationships than it saves in cash is a bad trade. A 5-day DSO improvement that costs nothing in customer relationships is a great trade.

A capable manager can articulate the trade-off for each lever in their part of the business — not in the abstract, but in specific R-value and operational-cost terms.

Why the CFO cares

Working capital sits in three CFO conversations.

Cash and liquidity management. Even a profitable business has to plan around its cash position. The working-capital position is the operational determinant of how much cash the business needs to hold and how much external financing it requires.

Cost of capital. Money tied up in working capital is money not earning a return elsewhere — what the course manual calls the opportunity cost. At any reasonable cost of capital, a R10m permanent working-capital position is costing the business R1m+ a year that doesn’t appear on the P&L explicitly.

Growth capacity. Whether the business can take on the next big order, the next expansion, the next acquisition, depends in part on its working-capital position. Strong working-capital management expands the optionality.

This is also why working capital comes up in business cases — any proposal that materially changes working capital should state that explicitly in the cost analysis section.

How working capital fits with the wider finance-for-managers picture

Working capital is one of the three or four most consistently under-taught topics in standard finance training for managers. It’s covered as skill #3 in the Financial Skills Every Manager Should Have framework — alongside skill #2 (distinguishing profit from cash, which is the conceptual sibling of this piece).

The connection between the two: a manager who understands skill #2 (profit and cash diverge because of accruals, timing, and working capital) but not skill #3 (the operational mechanics of working capital) understands the theory but can’t do anything about it. The course manual treats them as connected — Section Two introduces the matching rule and accruals, Section Five turns it into the operational working-capital chapter.

For the wider context of where budgeting and working capital sit together, see the main budgeting guide. Working capital is also the topic that most directly explains why some variance reports look fine on the P&L but the CFO is still worried — the cash impact is in the working-capital movement, not the variance.

What to do next

If you don’t know your cash conversion cycle for your part of the business — what days inventory, DSO, and DPO are running at right now — that’s the first calculation worth asking the finance team for. Most operational managers have never seen the number for their area. Having it once usually changes how a few decisions get made.

For structured training that covers the operational working-capital toolkit — formula, ratios, cash conversion cycle, forecasting working capital using ratios — JSF’s Budgeting and Cost Control course covers Section Five of the manual on this topic. For group cohorts, see finance training for managers and teams. Four days, Monday to Thursday mornings, live online with a max of six delegates. To talk through fit, request a callback.