A retailer with $200M in inventory and $50M overdue payables is solvent on paper but cannot pay rent. Working capital management is the discipline that prevents this from happening.
Working capital is current assets minus current liabilities. The current accounts that matter operationally are cash, accounts receivable, inventory, accounts payable, and accrued expenses. Net working capital tells you how much short-term capital is tied up funding the operating cycle.
KEY: More working capital is not better. Excess working capital means cash is trapped in receivables and inventory instead of earning a return. Too little working capital means you cannot pay bills.
The CCC measures how many days cash is tied up between paying suppliers and collecting from customers. It has three components.
Days Inventory Outstanding (DIO) is how long inventory sits before it sells.
Days Sales Outstanding (DSO) is how long it takes to collect after a sale.
Common mistakes
- Reversing the CCC formula sign. CCC = DIO + DSO − DPO. Trap: subtracting DSO instead of DPO yields negative CCCs everywhere and misleads ranking.
- Assuming a higher current ratio is always better. A current ratio of 4.0 may indicate idle cash, slow-moving inventory, or uncollected receivables, not strength. Trap: ranking firms purely by ratio magnitude without examining components.
- Including inventory in the quick ratio. The quick ratio deliberately excludes inventory because it may not convert to cash quickly. Trap: computing (CA / CL) and labeling it "quick ratio."
Bottom line
- Cash Conversion Cycle (CCC) = DIO + DSO − DPO. Lower is better; a negative CCC (Amazon, Walmart) means suppliers fund operations.
- DIO and DPO use COGS in the denominator, while DSO uses revenue.
- Liquidity ratios rank by strictness: Current > Quick > Cash. Quick excludes inventory; cash counts only cash plus marketable securities.
- Working capital = Current Assets − Current Liabilities. The objective is to minimize it without breaking operations.
Exam shortcut
For CCC, memorize "Inventory plus Receivables minus Payables, all in days." For liquidity-ratio strictness, remember CQC descending: Current (broadest), Quick (no inventory), Cash (cash and securities only). For primary vs. secondary liquidity, ask: "Would a healthy company use this routinely?" If yes, primary. If only under stress, secondary. Always benchmark CCC and liquidity ratios against industry peers, never across industries.
The full lesson (about 2,231 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- working capital and liquidity
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