Working Capital as a CFO strategic weapon

🛠 THE CFO EFFECT PLAYBOOK (Part II)

Step 1: Understanding Working Capital—Going Beyond the Ratio

Working capital, at its simplest, is your company’s ability to cover short-term obligations with short-term assets.

It’s a matching principle. Short term with short term.

In other words, can you convert enough assets into cash within a year to cover liabilities due within the same timeframe?

If you have more assets than liabilities in the short term…congrats! Your working capital is positive.

If you can’t convert those assets into cash faster, you’ll have to bridge that gap one way or another.

But here’s what’s wrong with the common definition used above.

Working capital isn't just about meeting immediate bills; it's about structuring your financial resources correctly.

Here's a common mistake many businesses make; one I've seen repeatedly during my banking career:

Funding long-term assets (like machinery or equipment) with short-term liabilities.

Imagine taking out a short-term loan to buy a machine…yes, many mid-market companies do that.

This asset will generate revenue over multiple years, but your repayment is due within months.

Suddenly, you're trapped.

You can't convert that long-term asset into immediate cash, yet you're obligated to repay quickly.

This mismatch creates stress on your liquidity, limits your strategic flexibility, and often leads businesses straight into a cash crisis.

So, here’s how I like to think about working capital:

The working capital (and even the current ratio) shows you if there’s a mismatch in the way you financed your long-term assets.

Let me explain.

The concept of a balance sheet is that it’s always balanced, right?!

Therefore, if your short-term liabilities are higher than your short-term assets, it means that you’re financing a portion of your long-term assets with short term liabilities.

Keep this in mind, it will be handy later on. 😉

Step 2: Fast Growth and the Hidden Dangers in Working Capital

Banks don’t like businesses with declining revenue because it signals that the company is heading into troubles.

But counterintuitively, banks don’t like fast growing businesses either.

You’re probably wondering why?

Here’s the answer.

Rapid growth feels great.

Revenue climbs, market share expands, and optimism runs high.

But here's the paradox: fast-growing companies usually see an increase in cash tied up in working capital.

Why? Because growth typically leads to longer cash conversion cycles.

The cash conversion cycle involves inventory turnover, how quickly customers pay their invoices, and how fast you pay your suppliers.

If your business pays suppliers promptly but takes too long to collect receivables or sell inventory, your cash gets trapped in operations.

One example of this is DTC companies during the COVID boom.

Most consumers were stuck at home.

They did not have opportunities to spend that cash on services which increased their disposable income.

That led to a hyper growth period for e-commerce businesses.

Most of them thought this was a long-term phenomenon and bought way too much inventory.

When the pandemic resumed, everyone stopped buying physical items frenetically.  

Suddenly, they found themselves bloated with slow moving inventory.

You know what’ the challenge with inventory?

It does not show up on your P&L, unless you:

- Sell it

- Write it down

- Write it off

This is why I love this saying: “There are two things you can do with inventory, sell it, or write if off.”

Obviously, this scenario does not happen every day.

But it’s a good reminder to check your inventory on a regular basis.

Step 3: When Sales Growth Can Actually Hurt Your Business

Let’s talk about a more probable scenario.

Sales teams are often eager to increase revenue.

To do so, they offer customers extended credit terms.

Sales soar, sure, but your receivables balloon.

Suddenly, you have higher sales numbers but less actual cash available, forcing you to rely heavily on your credit line.

Interest expense rises, eating away at profits and causing structural liquidity issues.

This is why it’s important to connect the P&L to your balance sheet in your analysis.

Alternatively, imagine another scenario.

Perhaps your margins temporarily shrink because you aggressively discounted slow-moving inventory.

While your gross margin may decrease short term, you quickly:

- Free up warehouse space

- Reduce inventory holding costs

- Improve your inventory turnover, and

- Ultimately enhance your cash flow.

Here, you've created a virtuous financial loop rather than a vicious one.

Both examples illustrate the deep interconnectedness of working capital management with overall financial health.

The key is not to view sales, inventory, receivables, and payables in isolation.

Every lever you pull in operations or sales reverberates through your entire financial model, impacting liquidity, interest expense, and long-term stability.

Step 4: Negative current ratio — When Your Ratios Flash Red

The current ratio is your current assets divided by your current liabilities.

A healthy current ratio should be above 1.20 (depending on the industry you operate in).

But what if you have a negative working capital or a current ratio below one?

This signals you're financing long-term assets with short-term liabilities.

I told you to keep that in mind earlier. 😉

This is a dangerous situation that requires immediate action.

Many companies rush to their banks, desperate to extend their operating lines.

Renegotiate longer payment terms with suppliers.

Tighten their customer credit policies.

Improve their inventory turnover.

But all these actions only temporarily don’t solve the underlying structural problem.

They only mask it.

Instead, address structural issues.

You need to fix the mismatch between your financing and long-term assets.

Thus, you need to negotiate long term financing to finance your long-term assets. 

Here are a few solutions you can use to fix the problem:

- Reduce dividends paid to shareholders

- Request a cashflow loan or a working capital loan from your bank instead of increasing your operating line

- Increase your margins to increase profitability and boost retained earnings

- Sell your long-term asset and get a lease-back

- Renegotiate your long-term loans and extend them over time if possible

- Shareholders to reinject money into the business either as capital injection or shareholder loan

- Big corporations can either issue new shares or raise bonds in capital markets

These structural fixes provide lasting stability, unlike short-term debt, which merely delays financial distress.

Step 5: Current ratio — Beyond the magic number

What’s a healthy current ratio?

We said that one and above will put you in the green.

But a ratio of 1.00x means that you don’t have much buffer.

This is why anything above 1.20x is supposed to be good.

But is anything above 1.20x really good?

How about a 2x or 3x or even 5x ratio?

Anything above 1.20x is good. It gives you some buffer. But excess isn’t good either.

When you start hovering above the 2x, it means that you are being too cautious.

This has two unexpected effects:

- If you have too much liquidity on your balance sheet, people start feeling comfy. They spend money without feeling the discipline that tight liquidity creates. You’d be surprised at how much people become creative when money supply dries.

- If it sits on your balance sheet chances are it’s not generating high returns. Instead of having money sleep in your bank account, put it to good use by investing that cash in something that generates higher returns. Maybe it’s time to take more risks.

Step 6: Working Capital as a Strategic Advantage

I hope that by now, you realize how working capital can be a powerful tool in your CFO arsenal.

The ultimate objective for any finance leader is turning working capital from a constant worry into a strategic advantage.

This means:

• Managing inventory efficiently, reducing excess stock, and improving turnover.

• Structuring receivables policies to incentivize quick payments from customers.

• Negotiating optimal payment terms with suppliers to hold cash longer.

• Ensuring the financial structure (debt vs. equity) aligns with the nature of your assets and your long-term strategic objectives.

These actions not only strengthen your current ratio but also improve overall financial health.

They reduce reliance on costly short-term debt and increase your resilience during market downturns or unexpected disruptions.

Connecting the Dots — Why Every Financial Metric is Linked

Above all, remember this crucial point: never analyze working capital in isolation.

Balance sheet, income statement, and cash flow metrics are deeply interconnected.

Your working capital position directly impacts profitability, liquidity, and ultimately, your ability to scale sustainably.

Next week, we'll dive even deeper.

We'll break down individual working capital components (receivables, inventory, payables, and cash) to show exactly how each one impacts your financial health and strategic options.

Until then, take a moment to reexamine your working capital strategy. Ask yourself whether your company’s growth is sustainable from a working capital perspective or whether hidden vulnerabilities could derail your trajectory.

Next Week’s Episode:

🔜 Working Capital Part II: How to go beyond ratios

Most companies obsess over profit and revenue…

…but ignore the goldmine hidden in their balance sheet.

Next Sunday, I’ll show you why mastering working capital ratios isn’t just an accounting exercise but it’s a strategic superpower.

Finance leaders who understand this know how to unlock trapped cash, reduce operational risk, and strengthen liquidity without raising a single dollar of capital.

Here’s what you’ll learn in Part Two of our Working Capital series:

✅ Why a “strong” current ratio can actually be a red flag
✅ How to use the quick ratio to detect inventory-driven liquidity risk
✅ What rising DSO tells you about sales quality and cash flow danger
✅ The hidden signals behind deferred revenue and DIO that most CFOs miss
✅ How to renegotiate DPO for maximum liquidity without damaging supplier trust

If your company is holding excess inventory, getting paid too slowly, or leaving supplier terms unoptimized, you're bleeding cash…and it’s time to fix it.

Because top finance leaders design liquidity.

Don't miss this episode if you want to turn your balance sheet into a weapon for sustainable growth.

Talk soon,