How to Calculate the Working Capital Gap

Revenue is not cash. For growing B2B businesses, the faster you grow, the more cash gets trapped in the cycle of buying inventory and waiting for customers to pay. This is the working capital gap.

The Cash Conversion Cycle

The gap is essentially the time (and money) difference between when you have to pay your suppliers and when your customers finally pay you. It is driven by three main components:

• Receivables (Days Sales Outstanding - DSO): How long it takes customers to pay.
• Inventory (Days Inventory Outstanding - DIO): How long stock sits before being sold.
• Payables (Days Payable Outstanding - DPO): How long suppliers give you to pay them.

A Simple Numerical Example

Consider a growing distributor:

Using a simplified daily run-rate (assuming a 30-day month and for simplicity, valuing everything near sales price):

• Receivables tied up: (₹50L / 30) × 60 = ₹100 lakh
• Inventory tied up: (₹50L / 30) × 30 = ₹50 lakh
• Supported by Payables: (₹50L / 30) × 45 = ₹75 lakh

The Gap: ₹100L + ₹50L - ₹75L = ₹75 lakh.

This business needs ₹75 lakh of permanent cash sitting in the system just to sustain current operations. If sales double to ₹1 crore next month, the gap doubles to ₹1.5 crore. Growth consumes cash.

What Lenders Look At

When evaluating a facility to bridge this gap, lenders typically review:

• The actual ageing of the receivables, and whether settlement occurs at 60 days or at 120.
• The credit quality of the buyers (can they be relied upon to pay?)
• The historical stability of the trade relationship.

Disclaimer: General information only, not financial advice. Calculations are simplified for illustrative purposes and do not represent formal underwriting criteria.