A worked example for Canadian SME owners. The business and figures are illustrative.

KEY TAKEAWAYS

• A seasonal landscaping business borrowed about $120,000 from its operating line every spring. Its cash conversion cycle was 100 days.
• Pricing four standard fixes showed that two of them, faster collection and ordering against stock on hand, released about $160,000 at negligible cost.
• The other two, customer deposits and split supplier orders, cost about six times more in lost margin than the interest they would have saved, so the owner declined them.
• Working capital should be optimized, not simply minimized. The right level depends on what that capital costs and what the business receives in return.

About this case. The business below is constructed to show how the cash conversion cycle works in a seasonal trade. It is not a description of a real company or client. The arithmetic is shown in full so you can apply the same steps to your own numbers.

A landscaping company borrowed about $120,000 from its operating line every spring. The standard advice for that problem is predictable: collect deposits, hold less inventory, and split large supplier orders into smaller deliveries. When the owner priced each option, two of them would have left the business worse off. The two that worked cost almost nothing, and together they released about $160,000.

The Spring Borrowing Problem

The company is a landscaping and hardscaping business in Ontario with revenue of about $2,400,000 a year and cost of sales (materials and direct job costs) of about $1,500,000, which leaves a gross margin of 37.5 percent. Most revenue is billed between May and October. Materials are bought in winter and spring, and payroll starts well before the first invoice is paid. Every spring the owner drew on the operating line to cover material deposits and wages, and treated this as the normal cost of a seasonal trade.

Over three years the spring draw grew from about $80,000 to about $120,000 while revenue and margin stayed flat. When profit holds steady and borrowing keeps rising, a longer working-capital cycle is one possible cause. In this case, the next step was to measure it.

How to Calculate the Cash Conversion Cycle for a Seasonal Business

The cash conversion cycle adds the days customers take to pay and the days inventory sits before it is used, then subtracts the days the business takes to pay its own suppliers. Using the last twelve months:

Customers paid in about 55 days on average. Larger commercial clients had gradually moved to longer terms, and each request had been accepted on its own.

Inventory sat for about 70 days. Stone, aggregate, and specialty materials were bought in bulk each winter to earn a volume discount.

The business paid its suppliers in about 25 days.

The cycle is 55 plus 70, minus 25, which is 100 days. These are annual averages. Inventory peaks in late winter before revenue has been billed, so the cycle from March through May is longer than 100 days. That is why the strain appears in spring and not evenly across the year.

Two figures size every option below. Daily revenue is $2,400,000 divided by 365, or about $6,575. Daily cost of sales is $1,500,000 divided by 365, or about $4,110.

Four Ways to Free Up Cash, and the Four Questions That Decide Them

For each option the owner asked four questions. How much cash does it release? When does that cash arrive? What does it cost each year in lost margin? What operating or commercial risk does it create?

The cost was then compared with the interest the released cash would avoid. The spring draw was treated as $120,000 outstanding for five months at an all-in rate of about 8 percent, which is $4,000 a year. Each dollar released during those months avoids about 3.3 cents a year in interest (8 percent times 5/12). That figure provides the financial benchmark: if an option costs more than the interest it avoids, the additional cost has to be justified by another benefit, such as lower liquidity risk or greater financing flexibility.

1. Faster invoicing and collection (adopted). Invoices had been going out about five days after work was finished. The new routine: invoice the day work is completed, offer electronic payment, call on day 31 for anything unpaid, and review overdue invoices weekly. Collection time fell from 55 days to 40. Fifteen days of revenue is 15 times $6,575, or about $98,600. The annual cost was a few hours of staff time a week, which is negligible. Interest avoided: about $3,300. The commercial risk was friction with large clients, so the two largest accounts, about a quarter of revenue, stayed on 45-day terms. The owner chose not to press them, because losing either account would cost more than carrying their receivables.

2. Ordering against stock on hand (adopted). A physical count found surplus pavers, aggregate, and edging left over from finished jobs, about a fifth of stock on hand, that had never been factored into reorders. Orders had been placed from habit and winter pricing. The new rule: before every order, check stock on hand, signed jobs, and supplier lead times, use surplus first, and keep safety stock on fast-moving base materials. Inventory days fell from 70 to 55. Fifteen days of cost of sales is 15 times $4,110, or about $61,600. The annual cost was negligible, because the business was using material it already owned. Interest avoided: about $2,050. The risk is a stockout, which the safety stock and lead-time check are there to prevent.

3. Customer deposits (declined). A 30 percent deposit on larger jobs would bring cash forward by an amount equal to about seven days of revenue, or $46,000. This is customer-funded cash, not a change in collection days. The owner estimated that the deposit requirement would cost the company two otherwise-winnable jobs a year, roughly $24,000 in revenue, or $9,000 in gross margin at 37.5 percent. Interest avoided: about $1,530. The deposit would cost nearly six times the interest it saved.

4. Splitting the specialty order (declined). Ordering about $300,000 of specialty material in two deliveries instead of one would cut average stock by about $28,800, roughly seven days of cost of sales. It would also lower the volume discount from 5 percent to 3 percent, which costs $6,000 a year. Interest avoided: about $960. The cost was more than six times the benefit, and two deliveries meant more exposure to spring supply allocation.

The two adopted changes release $160,200 against a $120,000 draw, so the interest they avoid is capped at the $4,000 actually paid. Payables were left alone, because the two main stone and aggregate suppliers controlled spring allocation and paying them later risked that.

The Result: $160,000 Released, and a Caution About Averages

Under the revised operating model, receivables fall to about 40 days and inventory to about 55. The cycle is 40 plus 55, minus 25, which is 70 days, down 30 days from 100. The cash tied up in the operating cycle falls by about $160,000, with margin per job unchanged.

That $160,000 is built from annual averages, so it measures the lasting reduction in cash tied up, not the spring low point. A month-by-month forecast from February through June confirms that, in this example, the improvement is sufficient to cover the historical $120,000 draw. Interest saved is at most $4,000 a year. The larger benefit is that the business no longer depends on the bank renewing the line at the same limit each spring.

Why Working Capital Should Be Optimized, Not Minimized

Most cash flow advice treats a shorter cycle as better in itself. This case shows why that is incomplete. Cash tied up in working capital has a cost: here, about 3.3 cents per dollar per year during the borrowing months. Releasing it has a cost too, in lost bids, lost discounts, stockout risk, or strained supplier relationships.

The two adopted changes removed working capital that was doing no economic work, so they cost almost nothing. The two declined changes would have given up something that earned more than it cost to finance: a purchasing discount in one case, winning bids in the other. Some working capital is waste, and some of it buys a discount, supply security, or revenue. A business may reasonably hold 70 days of stone if a winter discount or a spring shortage justifies it. Before trying to eliminate working capital, calculate which kind you are carrying.

Try It on Your Business

1. Calculate your three numbers from the last twelve months: days to collect from customers, days inventory sits, and days to pay suppliers. Use cost of sales, not revenue, for inventory and supplier days.
2. Repeat the calculation for your busiest quarter, and build a month-by-month cash forecast for the months you borrow. Annual averages hide the low point.
3. Size each option. Days saved on receivables times daily revenue, and days saved on inventory times daily cost of sales, give the cash released.
4. Set your benchmark. Multiply your all-in borrowing rate by the months you borrow, divided by 12. That is the interest avoided per dollar released.
5. Price each option. Multiply the cash it releases by your benchmark, then compare that with its annual cost in lost margin. If the cost is higher than the financing benefit, identify whether another benefit justifies the difference. If not, decline it and look for a cheaper way to release cash.
6. Start with changes that remove idle working capital: invoicing the day work is done, a set follow-up routine, and checking stock and signed jobs before every order.



Figures in this case are illustrative and rounded. Results in a real business depend on customer mix, supplier terms, and seasonality.

This article is part of eSupply Canada's Business Intelligence series for Canadian SME owners and operators.