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Working capital for MSMEs: the cash conversion cycle, explained with numbers
Profitable businesses run out of cash for structural reasons, not mysterious ones. Measure the gap between paying suppliers and being paid, then close it deliberately.
A profit and loss statement tells you whether the business worked. A cash conversion cycle tells you whether it can keep working next month. For most MSMEs the second question is the urgent one, and it is answerable with three numbers you already have in your books.
The three numbers that define your cash gap #
The cash conversion cycle is inventory days plus receivable days minus payable days. It tells you how many days of operations you must fund out of your own pocket or a bank limit.
- Inventory days = average inventory divided by cost of goods sold, times 365.
- Receivable days = average trade receivables divided by credit sales, times 365.
- Payable days = average trade payables divided by credit purchases, times 365.
A trading business at 45 inventory days, 60 receivable days and 30 payable days has a 75 day gap. At a monthly turnover of Rs 40 lakh, that is roughly Rs 1 crore of working capital permanently tied up — money that never appears as an expense in the profit and loss statement and therefore never gets discussed.
Why profitable businesses still run dry #
Growth consumes cash. Every additional rupee of sales at a 75 day cycle needs roughly 20 paise of funding before it returns. A business growing 40 per cent a year on a thin margin can be profitable on paper and insolvent in practice.
Three other patterns show up repeatedly in MSME books: a large customer quietly stretching payment terms, inventory bought on volume discounts that then sits for two seasons, and statutory dues used as a short term loan, which is the most expensive borrowing available.
Closing the gap, in order of cheapness #
Work down this list. The first four cost nothing but discipline.
- Invoice on dispatch, not at month end. Two weeks of delay is two weeks of funding.
- Put payment terms in writing on the purchase order and state the consequence of delay.
- Age receivables weekly and call at day 3 past due, not day 30.
- Cut slow-moving stock even at a discount; cash today beats margin in eighteen months.
- Negotiate supplier terms — often available in exchange for reliability, not price.
- Only then consider funding.
Which funding fits which gap #
| Instrument | Fits | Watch for |
|---|---|---|
| Cash credit or overdraft | Recurring inventory and receivable cycles | Drawing power based on stock and book debt statements — submit them monthly or the limit shrinks |
| Invoice discounting or TReDS | Long-dated receivables from large buyers | Recourse terms; know who carries the risk if the buyer defaults |
| Term loan | Equipment and capacity, never working capital | Repayment schedule matched to when the asset earns |
| Government-backed MSME credit schemes | Businesses without collateral | Eligibility rests on registration and filing history being current |
Note the last row. Access to the cheapest MSME credit is gated on clean filings — registration, GST returns and audited statements. Compliance is a financing strategy, not an overhead.
A monthly cash discipline that fits on one page #
Run this on the same day every month.
- A 13 week rolling cash forecast, updated weekly, showing the lowest projected balance.
- Receivables ageing with an owner named against each bucket.
- Payables ageing, with statutory dues listed first and never deferred.
- Inventory ageing with anything over 90 days flagged for action.
- One number reported to the owner: days of cash on hand at current burn.
Businesses that watch days of cash on hand rarely have a crisis. They have decisions, made early, while the options are still cheap.