Working Capital Management Guide [2026]

DIO (Days Inventory Outstanding)

Formula: (Average Inventory ÷ COGS) × 365

How long inventory sits before being sold. A manufacturer with $200K average inventory and $1.2M annual COGS has DIO = ($200K ÷ $1.2M) × 365 = 61 days. Lower is better — every day inventory sits costs storage, insurance, and risk of obsolescence. But too low means stockouts and lost sales.

DSO (Days Sales Outstanding)

Formula: (Accounts Receivable ÷ Annual Revenue) × 365

How long customers take to pay after you invoice them. A business with $80K AR and $600K annual revenue has DSO = ($80K ÷ $600K) × 365 = 49 days. If your terms are Net 30 and DSO is 49, customers are taking 19 extra days — and you're financing their float.

DPO (Days Payable Outstanding)

Formula: (Accounts Payable ÷ COGS) × 365

How long you take to pay your suppliers. A business with $50K AP and $400K COGS has DPO = ($50K ÷ $400K) × 365 = 46 days. Longer DPO is generally better — you're using supplier credit as free financing. But too long damages relationships and may trigger late fees.

Reduce DIO — Move Inventory Faster

• • ABC analysis: Categorize inventory by value (A=high value, C=low value). Focus optimization on A items — they tie up the most cash.
• • JIT (Just-in-Time): Order materials to arrive just before production needs them. Requires reliable suppliers. Toyota invented this; small manufacturers can adapt it.
• • Safety stock optimization: Don't hold 6 weeks of safety stock if lead time is 1 week. Recalculate based on actual lead time + demand variability, not gut feel.
• • Liquidate slow movers: Inventory older than 90 days that hasn't moved → 30% discount sale. Cash now beats potential full-price sale in 6 months.
• • Dropshipping: For e-commerce, eliminate inventory entirely — suppliers ship directly to customers. Margin sacrifice vs zero inventory cost.

Reduce DSO — Collect Faster

• • Invoice immediately: Do not batch invoices to the end of the month. Invoice the day work is complete or goods ship. Every day of delay adds a day to DSO.
• • Offer early payment discounts: “2/10 Net 30” = 2% discount if paid within 10 days, full amount due in 30. This is equivalent to 36.7% annualized interest for the customer — powerful incentive.
• • Require deposits or progress payments: For large projects, collect 30-50% upfront and milestone payments. This converts AR into cash before project completion.
• • Automate AR follow-up: Send email reminders at 7 days before due, on due date, and 3/7/14 days past due. Most customers pay late because they forgot, not because they can't.
• • Accept multiple payment methods: ACH (free, 2-3 days), credit card (fee but instant), wire (fast but expensive). Make it dead simple for customers to pay you.

Optimize DPO — Pay Later (Without Burning Bridges)

• • Negotiate longer terms: Ask suppliers for Net 45 or Net 60 instead of Net 30. If you consistently pay on time, most suppliers will extend terms — especially for larger orders.
• • Use business credit cards strategically: Pay suppliers with a card that offers 30-day float + rewards. Pay the card balance in full before interest accrues. This adds 25-55 days of free float.
• • Don't pay early for small discounts: “2/10 Net 30” sounds good, but only if you have the cash. A business with tight cash flow is better off paying Net 30 and preserving working capital — 2% discount vs 20%+ cost of a short-term loan.
• • Schedule payments, don't react: Set all supplier payments to process on the due date via ACH — not when the invoice arrives. This extends DPO without damaging relationships.
• • Beware of stretching DPO too far: Excessive DPO (over 90 days) signals financial distress to suppliers. They may tighten terms, require prepayment, or report to credit agencies. Stay within 15-30 days past agreed terms max.

🚩 DSO is rising quarter over quarter

Customers are paying slower. Either your credit policy is too loose, your collections process is weak, or your customer base is deteriorating. Calculate aging buckets: 0-30, 31-60, 61-90, 90+ days. If the 61+ bucket is growing, act immediately.

🚩 Inventory turnover is slowing

You're buying more than you're selling. Run a stock-to-sales ratio by SKU. Any item where stock exceeds 12 weeks of projected sales needs a markdown or return-to-supplier. One slow quarter of inventory buildup can wipe out a year of profit margin.

🚩 You're stretching AP to fund operations

You pay suppliers late not because you want to optimize DPO, but because you don't have the cash. This is fundamentally different from strategic DPO management. If you're on credit hold with any supplier, working capital is in crisis.

🚩 Short-term debt is growing faster than revenue

You're using credit lines and credit cards to cover operating expenses. This is a spiral: interest costs increase fixed expenses, which increases BEP, which requires more sales to cover, which may require more credit. Break the cycle by cutting costs or injecting equity.

🚩 Cash conversion cycle exceeds 90 days

For most non-manufacturing businesses, a CCC over 90 days means you're financing 3+ months of operations out of pocket or with debt. You need external working capital financing (line of credit, AR factoring, inventory financing) or your cash will run out.