Effective cash-flow management is crucial for any business. For companies that rely on inventory, such as e-commerce retailers and wholesale distributors, working capital turnover is a critical lever in maintaining operational efficiency and financial health. Optimizing this turnover means striking the right balance between capital investment in stock and timely conversion into sales, to ensure liquidity while minimizing costs.

The supply chain is a driver of the working capital cycle, starting with procurement of inventory. Strategic supplier relationships and procurement practices directly influence cash flow, particularly when negotiating payment terms like net 30 or net 60. These enable businesses to defer payments, optimizing liquidity by aligning cash outflows with revenue generation. Forward-thinking leaders embrace these opportunities to enhance financial agility, and ensure that inventory is available to meet demand without unnecessarily tying up capital.

However, inventory management isn’t just about purchasing and storing. Once the goods are in the warehouse and ready for unit sales, you need working capital for marketing and advertising. You also incur costs for order fulfillment and delivery. The entire process forms the backbone of the supply chain working capital cycle.

For companies looking to finance their supply chain operations, aligning working capital financing with supply chain timelines and inventory turnover cycles is a powerful strategy. By synchronizing financing with the length of the cash conversion cycle, they can ensure that they borrow the right amount for the correct duration. For example, if it takes four weeks to receive inventory and eight weeks to sell through it, a 90-day loan might be ideal. The loan should cover the cost of purchasing the inventory, which will be repaid as the products are sold and revenue flows in.

This cyclical approach allows businesses to roll over loans at the end of one cycle and apply them to the next inventory order. If a company sells its stock in eight weeks but can reduce the supply chain timeline to six weeks by optimizing logistics, it can shorten the borrowing period which reduces costs.

Benefits of Shorter Loan Durations

Shorter supply chain cycle times significantly lower borrowing costs. The quicker a company turns its inventory, the less time it needs to hold a loan, which directly impacts financing fees. Borrowing for, say, six weeks instead of eight for the same amount of inventory reduces loan costs. This cost-saving dynamic encourages businesses to carefully evaluate how much inventory they need to buy, how fast they can sell it, and how efficiently they can manage their supply chain. 

Inventory discounts are often tied to volume purchases. While buying larger quantities of stock can lower the per-unit cost of goods, businesses must weigh these savings against the potential risk of overstocking. Over-purchasing can lead to excess inventory, tying up working capital in goods that may not sell in a timely manner, or worse, become obsolete. Business owners should also weigh the bulk discounts against the additional expense of larger and longer-term loans. Understanding and managing this interplay is critical to financial health.

For example, if a business can purchase inventory for six weeks at $1 per unit or 12 weeks at $0.70 per unit, the cost savings on the unit price can seem attractive. However, if it takes too long to sell the stock, those savings might be negated by increased financing fees and the risk of unsold or stale inventory. Striking the right balance between volume discounts and manageable turnover times is key.

Pitfalls of Excess Inventory

Holding onto too much inventory introduces the risk of staleness. Products tied to trends, such as fashion items or seasonal goods, can quickly lose value if overstocked. This is particularly true for items with a clear expiration date or limited selling window — think of an election campaign T-shirt. As you get closer to an election, holding onto excess stock of these items is a risky gamble (particularly for the losing candidate’s items). Similarly, products that depend on consumer trends, such as certain electronics or branded merchandise, may lose appeal as new items hit the market.

It’s essential to optimize order volumes, aligning purchase orders with forecasted sales to avoid the potential waste of overstock. Businesses must plan for both the financial and market risks of holding inventory, balancing the cost savings from bulk buying with the possibility of unsold products.

For small to medium-sized businesses, particularly those just starting to scale, optimizing working capital turnover can seem daunting. They might lack sophisticated financial systems or the expertise to fine-tune their supply chain operations. Education about working capital management and its impact on cash flow is essential for business owners who want to run their operations efficiently.

By understanding the full scope of the supply chain, from inventory procurement to sales, businesses can make more informed decisions about financing and stock management. This enhanced financial literacy enables them to strike the right balance between capital expenditure, operational needs and cost efficiency.

Optimizing working capital turnover through effective supply chain management is an essential strategy for maintaining financial health and operational efficiency. By aligning loans with inventory turnover, reducing supply chain timelines, and carefully balancing inventory purchases, businesses can significantly cut costs and boost profitability. Moreover, fostering financial literacy among business owners helps them make informed decisions that support long-term growth. In an increasingly competitive market, a well-optimized supply chain can make all the difference.

Eric S. Youngstrom is founder and chief executive officer of Austin-based Onramp Funds.