A distributor grows revenue 30% and reports its best year. Its bank calls in March to say the working capital limit is fully drawn.
Nothing has gone wrong. Growth consumes cash, and the amount it consumes is measurable in advance from three numbers that every annual report discloses.
The three components
Inventory days. Inventory divided by cost of goods sold, times 365. A distributor holding ₹780 crore of stock against ₹3,900 crore of cost of goods sold carries 73 days.
Use cost, not revenue, in the denominator. Using revenue understates the figure and is a common mistake.
Receivable days. Receivables divided by revenue, times 365. ₹640 crore against ₹4,800 crore of revenue is 49 days.
Payable days. Payables divided by cost of goods sold, times 365. ₹540 crore against ₹3,900 crore is 51 days.
The operating cycle is inventory days plus receivable days: 122 days from buying material to collecting cash. The cash conversion cycle subtracts the credit suppliers extend: 71 days.
That 71 days is the period the company has to fund itself. The 51-day gap between the two figures is the free funding suppliers provide.
What the cycle costs
The arithmetic that makes this concrete is one line.
A company with ₹4,800 crore of revenue and a 71-day cycle that grows 30% needs to fund an additional ₹280 crore of working capital in that year, before it has collected a rupee of profit on the new sales.
Take the revenue increase, multiply by the cycle in days, divide by 365. ₹1,440 crore of new revenue times 71 over 365 is ₹280 crore.
That money has to come from retained profit, from a bank, or from suppliers. If the company's profit after tax on the incremental revenue is less than ₹280 crore, growth is cash-negative and the gap is borrowed. This is why fast-growing, genuinely profitable companies run out of cash, and it is one of the commonest ways a good business fails.
Why the cycle can be negative, and what that means
A supermarket sells for cash in a fortnight and pays suppliers in 60 days. Its cycle is roughly minus 45 days.
Growth generates cash for that business rather than consuming it. Every new store funds part of its own working capital from the day it opens, because the customers pay before the suppliers do.
That structural difference, rather than any margin advantage, is most of why organised retail can expand quickly on modest capital while a capital-goods business expanding at the same rate needs a rights issue. It is also why the same growth rate means completely different things in the two sectors, and why comparing their capital requirements without looking at the cycle produces the wrong conclusion.
Negative cycles occur wherever the customer pays before the supplier does: supermarkets, quick-service restaurants, subscription software, insurance and airlines that sell tickets in advance.
Where to find the numbers in an Indian annual report
Inventory, trade receivables and trade payables are all on the face of the balance sheet, with notes breaking each into components.
Cost of goods sold is not a line in an Indian statement, which presents expenses by nature rather than by function. Build it by adding cost of materials consumed, purchases of stock-in-trade, and changes in inventories of finished goods and work in progress. That sum is the equivalent.
Use average balances where the year-end figure moved a lot, since a company that acquired a business in March has a closing balance that never participated in the year's trading.
And where revenue is seasonal, compute receivable days on the last quarter's revenue annualised rather than on the full year, because a March-quarter push disappears into an annual average.
The three ageing disclosures that turn the ratio into a finding
The ratio tells you the average. The ageing schedules tell you the distribution, and the distribution is where the information sits.
Receivables ageing is now presented in fixed buckets in Indian filings. What you want is the share beyond six months and whether it is growing. A company whose total receivables grew 20% while the over-six-month bucket grew 60% has not gained larger customers; it has stopped collecting from somebody. The schedule also separates amounts due from related parties, which is a governance question rather than a working capital one.
Inventory composition splits into raw materials, work in progress and finished goods. Raw materials building up is a purchasing decision. Work in progress building up points at a production bottleneck. Finished goods building up means the company made things nobody has bought, and it leads a demand disappointment by a quarter or two.
Payables to micro and small enterprises are disclosed separately, along with any interest due on payments made beyond the statutory period. A company with a rising balance there is not negotiating better terms. It is paying its smallest suppliers late.
Reading a lengthening cycle
Each component lengthens for different reasons, and each reason has a different severity.
Receivable days rising while revenue accelerates is the most reliable early warning in accounts. It can mean a genuine shift toward larger customers with more bargaining power, a push of stock into distributors at the end of a quarter, or customers who cannot pay. The ageing schedule distinguishes them.
Inventory days rising is the earliest visible sign of a demand problem, because production plans are set months before sales disappoint. It is also the setup for a write-down, since stock that has not moved will eventually be marked below cost.
Payable days rising is the ambiguous one. It can mean the company gained scale and negotiated better terms, which is a genuine improvement. It can equally mean the company is short of cash and paying late, which is the beginning of a supply problem. The two look identical in the ratio and different in the micro and small enterprise disclosure.
The signal worth more than all of them
A falling working capital requirement while sales grow.
That combination usually means the business gained bargaining power somewhere: with customers, with suppliers, or over its own inventory through better forecasting. It is one of the best signals in fundamental analysis and it is almost never announced, because it happens gradually and does not fit into an investor presentation.
Compute working capital as a percentage of revenue for five years. A company whose ratio fell from 22% to 15% while revenue doubled has released cash equal to a meaningful fraction of a year's profit, without any change in its margin.
What to strip out before analysing
The version of working capital that is useful for analysis excludes cash and short-term borrowings, because neither is operational.
A company with ₹1,775 crore of current assets and ₹1,005 crore of current liabilities has ₹770 crore of working capital on the face of the balance sheet. If ₹260 crore of the assets is cash and ₹300 crore of the liabilities is a working capital loan, the operating figure is ₹810 crore, and it is the operating figure that moves with sales.
Getting this right matters for a discounted cash flow, where the working capital movement is subtracted from the cash flow. Including a change in the bank balance in that line double-counts cash.
The routine
Once a year, from the filings rather than from a screener, compute the three components and the cycle for five years and for five peers, all identically.
Then read the ageing schedules for the company you care about.
Then compute the funding requirement implied by next year's growth, and check it against the company's own cash generation and its undrawn credit lines, which are disclosed.
Three steps. They take about half an hour and they answer a question no margin analysis can, which is whether this company's growth pays for itself or has to be borrowed.
Why this sits so close to the front of the work
Working capital is where trading problems appear before they reach the income statement.
A customer in difficulty stops paying before the sale is reversed. Weak demand shows up as unsold inventory before it shows up as lower revenue. A company under funding pressure stretches its suppliers before it defaults on a bank.
All three are visible in three ratios and two ageing tables, computed from a document anyone can download, several quarters before the profit line moves.
Sector norms, and why the level means nothing on its own
The cycle is set by the business model far more than by management, which is why comparing across sectors produces nonsense.
A jeweller carries months of inventory because the stock is the shop. A supermarket turns its stock in a fortnight and pays in sixty days, so its cycle is deeply negative. A capital-goods maker building custom equipment has receivables measured in months because the customer pays against milestones. An information technology services firm at 70 days of receivables is normal, and a cash-and-carry retailer at 70 days is a fraud investigation.
So the useful comparison is always within a sector, and the useful reading is always the trend rather than the level.
Which is also why a company that changes its cycle materially without changing its business has changed something else. Terms, customers, or the truth of the receivable.
What to do with the answer
Three uses, in increasing order of value.
Forecast the funding. Next year's revenue growth multiplied by the cycle gives the working capital the company will need. Set it against the company's own cash generation and its undrawn credit lines, which are disclosed, and you know whether the growth plan is funded.
Value the improvement. A company that reduces its cycle from 71 days to 55 days on ₹4,800 crore of revenue releases roughly ₹210 crore of cash, once, without any change in margin. That is a real return to the owner and it is invisible in the income statement.
Test the story. Management describing a shift toward larger, better customers should show up as longer receivables and better margins. Management describing better inventory discipline should show up as lower inventory days without a fall in gross margin. Where the numbers do not move the way the narrative says they should, the narrative is the thing to doubt.
The version for a business with no inventory
For a services firm or a subscription business, inventory days are zero and the cycle reduces to receivable days minus payable days.
For a subscription business collecting in advance, it goes further: the deferred revenue balance is a liability that funds the business, and the cycle can be strongly negative. A software company collecting a year upfront has the customer's money for eleven months before delivering the service, which is why the deferred revenue balance is one of the few genuinely forward-looking numbers on a balance sheet.
Growing deferred revenue means customers are committing further ahead. A falling balance is a revenue decline that has not yet reached the income statement.
Different business, same arithmetic, opposite sign.
Why working capital shows the problem first
Trading difficulties reach the balance sheet before they reach the income statement, and they reach it in a specific order. A customer under pressure stops paying long before anyone reverses the sale, so receivable days rise while revenue looks fine. Weak demand appears as unsold finished goods months before it appears as lower sales, because production plans were set against a forecast. A company short of cash stretches its suppliers before it misses a bank payment, and the disclosure of amounts owed to micro and small enterprises makes that visible. All three of those are computable from three ratios and two ageing tables in a document anyone can download, and all three typically appear several quarters ahead of the profit line moving. That is why working capital analysis sits near the front of the work rather than in the appendix where most templates put it.
Receivables tell you about the customer.
Inventory tells you about demand.
Payables tell you about the company itself.
One number, computed three ways, and why they differ
The same company can be quoted at three different cycle lengths depending on how the ratios were built, which is why the figure has to be computed rather than collected.
Using revenue in the inventory and payable denominators instead of cost of goods sold inflates both, because revenue exceeds cost by the gross margin. At a 35% gross margin that error shortens reported inventory days by about a third.
Using year-end balances rather than averages distorts any year with an acquisition, a large seasonal build, or a March push into the channel.
And using standalone rather than consolidated figures for a group whose subsidiaries hold the inventory produces a cycle for a legal entity rather than for a business.
Build it once, from consolidated statements, with cost in the denominator and average balances, and apply the same recipe to every peer.
Consistency beats precision here.