Why working capital matters for your shop

Working capital management plays a critical role in the financial health of every shop

Shops should actively monitor and optimize inventory, receivables, and payables.

Many professionals in the metalworking industry do not understand how important cash flow is to their business.

Working capital management plays a critical role in the financial health of every shop. The industry is capital-intensive, inventory-heavy, and highly sensitive to fluctuations in raw material prices, customer demand, and production cycles. Effective working capital analysis helps shops maintain liquidity, control costs, and sustain operations while navigating long production lead times and competitive pricing pressures.

Understanding working capital

Working capital is defined as the difference between current assets and current liabilities. It represents a company’s ability to meet short-term obligations using short-term resources.

The formula is pretty simple:

Working Capital = Current Assets − Current Liabilities

In every shop, current assets typically include raw materials, work-in-process (WIP), finished goods, accounts receivable, and cash. Current liabilities mainly comprise accounts payable, short-term borrowings, accrued expenses, and taxes owed.

The metalworking industry has many unique characteristics that affect working capital. These include:

1. High inventory requirements - Shops often maintain substantial inventories because they have to bulk-purchase metals to hedge against price volatility, have long lead times to purchase specialty materials, and need on-hand materials for custom or project-based production. This results in a significant portion of working capital being tied up in raw materials and WIP, increasing carrying costs and liquidity risk.
2. Long production and collection cycles - Production, especially in heavy engineering, construction, and industrial equipment, may span many weeks and even months. Payment is often received after delivery and project milestones, which leads to high accounts receivable balances and an increased reliance on short-term financing.
3. Volatile raw material prices - Metal prices fluctuate based on global supply and demand. Rising prices increase inventory valuation and working capital needs, while falling prices can lead to inventory write-downs and margin pressure.

Inventory is one of the largest components of working capital in most shops, and good inventory management is key to managing working capital components.

The challenges of inventory management include overstocking caused by uncertain demand, obsolete or slow-moving materials, and high storage and handling costs. It’s a good idea to keep track of just a couple of metrics: inventory turnover ratio and days inventory outstanding (DIO).

Improving forecasting, adopting just-in-time practices where feasible, and using ERP systems significantly enhances inventory efficiency.

Accounts Receivable

Shops often have to sell on credit, especially to large industrial or government clients.

With this scenario come the risks of delayed payments and the concentration of receivables among just a few large customers.

The key metrics to keep an eye on here are the receivables turnover ratio and the days sales outstanding (DSO). Strict credit policies, milestone-based billing, and early payment incentives can reduce receivable days.

Accounts Payable

Managing payables effectively helps fund operations without straining supplier relationships. It’s a good idea to negotiate longer payment terms with metal suppliers and align payables with the receivables cycle.

Watch the payables turnover ratio and days payable outstanding (DPO) metrics. An optimal balance helps ensure liquidity without damaging supply chain reliability.

Working Capital Cycle

The cash conversion cycle (CCC) is a vital indicator of efficiency. Essentially, it is the total number of days it takes for a company to buy inventory, sell it, and collect cash from customers. A shorter CCC indicates that a company recovers cash more quickly, and a longer CCC means cash is tied up longer in operations.

In manufacturing, the CCC is typically longer than in many other sectors because of extended production and collection periods. Reducing this cycle improves cash flow and reduces dependency on external financing.

CCC is defined by the equation CCC = DIO + DSO – DPO.

DIO, or the average number of days a company holds inventory before selling it, can be measured by multiplying the cost of goods sold average inventory by 365 days. This measures inventory efficiency. A low DIO means there is a fast inventory turnover.

DSO is the average number of days it takes to collect payment after a sale. It is measured by multiplying the revenue average accounts receivable metric by 365 days. DSO measures collection efficiency, and a low DSO means there is fast cash collection.

DPO is the average number of days a company takes to pay its suppliers. The The cost of goods sold average accounts payable times 365 days, it is an indicator of payment timing. A high DPO means a company keeps its cash longer.

How this all works together

DIO (or how long inventory sits) plus DSO (how long customers take to pay) minus DPO (the time a company delays paying suppliers) results in number of days cash is tied up in any operating cycle.

Poor working capital management has many costs, including:

• Increased borrowing costs.
• Production disruptions caused by cash shortages.
• Reduced profitability despite strong order books.
• Conversely, efficient working capital management improves:
• Operational flexibility.
• Ability to absorb raw material price shocks.
• Overall return on capital employed.

A few key strategies for improvement can be implemented pretty easily. First is demand-driven production planning, which closely aligns production schedules with confirmed orders to reduce excess WIP. Second is collaborating with suppliers. Long-term contracts and vendor-managed inventory can stabilize material supply and cash outflows. As always, technology adoption can help. ERP and inventory optimization tools improve visibility and decision-making. Last is financing. Invoice discounting, working capital loans, and trade finance products help bridge cash flow gaps.

Working capital analysis is especially critical in metalworking shops because of high inventory levels, volatile input costs, and long operating cycles. Companies that actively monitor and optimize inventory, receivables, and payables are better positioned to maintain liquidity, withstand market fluctuations, and achieve sustainable growth. In an industry where margins are often thin, efficient working capital management can be a decisive competitive advantage.

Mark Borkowski is president of Mercantile Mergers & Acquisitions Corporation, [email protected], www.mercantilemergersacquisitions.com