Firing Up the Flywheel: Working Capital Warfare III

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I love Costco.

And not just for the giant tins of baked beans… although, the Secret CFO household does get through a lot of beans.

I love the utter marvel of its business model.

150,000 square feet of pure retail perfection. I'd estimate at least 75% is customer-facing. And the high ceiling means stacking five pallets high, leaving almost no back room.

And that space is filled with just 4,000 SKUs. Sounds like a lot, until you consider the 100k+ you'd find in a Walmart.

There's a core lineup of reliables you know will always be there: giant slabs of Kirkland water bottles, glorious rotisserie chickens, and, of course, the famous $1.50 hotdog and Coke deal.

But Costco will also sideswipe you. A cashmere jumper, a hot tub, or, if you are having a particularly susceptible afternoon, an impulse kayak.

Costco does around $250m of sales per warehouse per year. Their average rate of sale per SKU is over $1,000 per week per store. Which is, frankly, astonishing.

And that intensity creates the magic in the business’ funding and growth.

Moving inventory that fast means they can keep stock levels tight. Reliable sales levels at a SKU level mean lower safety stocks and shorter lead times. Their days inventory outstanding sits at around four weeks, remarkably low when you consider the product mix includes plenty of bulky, slow-moving items. No kayak for me, btw… yet.

A tight range also means supplier relationships are extraordinarily simple. When Costco buys beans, they're not asking for ten sizes, four packaging formats, and a range review every quarter, all in the name of offering consumers "choice."

No. Costco wants one SKU. In a big fucking tin.

That simplicity translates into ordering power: enormous volumes of single SKUs, which drive better pricing. But it also means they can pay their suppliers quickly. Typically around 30 days from invoice.

No messing around. No being dragged into HQ once a year to have some snot-nosed buyer squeeze you for 120-day credit terms while smiling through their teeth.

Costco carries around eight weeks of current liabilities on its balance sheet. Which means their cash conversion cycle sits at negative four weeks (DIO of four weeks minus a fully loaded payables and accruals outstanding of eight weeks). Accounts payable makes up half, the rest is accrued member rewards, deferred membership fees, shop-card liabilities, insurance accruals, and other operating accruals.

They aren't the only retailer with a cash conversion cycle of negative four weeks. But most of them have to beat the hell out of their suppliers to get there. For Costco, it's sustainable because it's structural, built into the design of the business, not extracted from the people they depend on.

Now think about what that means when they open a new warehouse.

Let's say a new site costs $80m to build. I don't know the exact number, but it's probably not far off. That warehouse will generate $250m of additional sales, maturing to around $10m of additional EBIT, assuming a 4% conversion rate.

But $250m of sales, run through a negative four-week cash conversion cycle, generates around $20m of additional negative working capital.

In other words: 25% of the CapEx bill is funded by suppliers and customers as soon as the doors open. Meanwhile, Costco HQ enjoys a marginal $10m of EBIT for a net $60m of capital outlay. Pretty sweet.

Put another way, for every four new warehouses Costco builds, the inventory for all four, plus the full build cost of one of them, is effectively funded by the people they buy from and sell to. All of whom are happy to participate.

And they've been doing this for decades.

You better believe that dynamic is a big part of why they won.

In week one we established why working capital is SO strategic.

Last week, we broke down the drivers of working capital volatility, what they mean for forecasting, and how to size your true working capital need.

This week we get into the different working capital cycle types, and how to design yours to win.

And you better believe you get to design it…

In the opening story, you heard how Costco used working capital as a structural growth weapon. But business history is littered with them: 

Dell. The Dell story is a supply chain and working capital marvel. Dell computers were built to order, meaning they could grow without having to pay for warehouses full of machines nobody had bought yet. Were their computers the best? Who knows. But it didn't matter; with a model this capital-lite in such a capital-intensive industry, they were destined to win.

Amazon. Bezos was obsessed with free cashflow from day one. When a customer bought a book in 1995, their card was charged immediately. The distributor (in those days much bigger businesses than Amazon) would wait a few months for payment. That float funded so much of the distribution center infrastructure build out. Amazon reached maintainable free cashflow positive years before their first GAAP profit.

McDonald's. Not the franchisee, though it's not a bad business. But for McDonald's Corp, the franchisor… They get upfront franchise fees and ongoing royalties, which can be deployed immediately into new properties to grow the system further. If they'd collected those fees in arrears on 60-day terms, we might be eating someone else's burgers.

Now I know what you are thinking… I’m reporting classic survivorship bias. 

These giant businesses survived because they managed explosive growth brilliantly. They protected their engines while traveling at hundreds of miles per hour.

One commonality: Working capital structure was never a byproduct of the business model; it was hardwired into the fabric of the model itself.

And that meant trade-offs. McDonald's almost certainly walked away from franchisee sales who couldn't support the working capital requirements. Dell had to master the extraordinary operational challenge of building to order, and explain to customers why they had to wait a little longer than for a machine sitting on a shelf. Bezos presumably limited his supplier pool in the early days to those who would offer long enough terms.

It's about choices.

Most businesses make their business model choices, then figure out what that means for working capital.

These businesses made working capital central to the choices themselves.

There is a secret growth weapon hiding in the working capital of almost every business. As CFO, if you can sculpt it out, it's the most extraordinary gift you can give to your business.

The rest of this post is about how you find it.

And one of the most important choices you make is on the shape of your working capital. The shape is the unique relationship between your sales/growth rate and the level of working capital needed to support that level of sales.

There are broadly five unique shapes:

The options are a function of the choices you make about your business model. And, crucially, the execution levers that are important are unique to your shape.

Let’s dive into each shape and its quirks now:

Positive working capital is like the default shape of working capital. Some businesses have it because their industry demands it. Others because they haven’t managed it, and end up here by default. But you can still optimize it through careful credit management, inventory controls, and strong commercial relationships.

Industries: B2B manufacturing, wholesale distribution, staffing and recruitment, specialist trade suppliers, industrial equipment, automotive parts, building materials, etc.

Working Capital Component Mix: Dominated by receivables and inventory, with payables providing some offset but rarely enough to neutralize the net position. The net position is a permanent feature of the capital base.

Relationship With Growth: Profit grows faster than cashflow, often dramatically so. Every new dollar of revenue requires more working capital to support it, so the faster you grow, the more fuel you need to pour in.

Strengths: Inventory depth and making credit available can be a real competitive advantage (your customers want negative working capital too!) The structure is well understood by lenders and relatively straightforward to finance compared to more complex working capital types.

Vulnerabilities: Capital intensive by nature and unforgiving when things go wrong. A significant bad debt can wipe out months of margin in a single write-off. Inventory is a constant balancing act, breadth of range drives availability, and customer choice vs a direct and permanent cashflow cost.

Seasonality adds another layer of risk. In businesses with pronounced peaks, the working capital build into the busy period has to be funded before the revenue lands.

In high-growth businesses, sleepwalking into an overtrading problem is spectacularly common. Rapid growth drinks all the available cash, and the business doesn't realize until it's too late, locked into a mental model that profitable growth must always be good.

And in a downturn, receivables slow and inventory builds simultaneously. That double squeeze can be absolutely brutal.

KPIs: DSO, DIO, DPO, cash conversion cycle, working capital as % of revenue, overdue debt as % of ledger, inventory days by category

Key Levers To Make It Work For You: Customer credit terms, overdue debt collection discipline, SKU rationalization, inventory forecasting accuracy, supplier credit term negotiation, deposit or advance payment structures where the commercial relationship allows it. In other words, full hand-to-hand combat across every component.

Negative working capital is like rocket fuel for growth. It’s underpinned by great supply relationships, and tight inventory control. But it’s not all gravy... It’s an equally powerful force in reverse if your business falls into decline.

Industries: Retail, ecommerce, restaurants, ticketing and live events, airlines, membership clubs, B2C broadly

Working Capital Component Mix: Low or minimal receivables. Working capital is dominated by inventory, trade payables, and related accruals.

Relationship With Growth: The dream. Every additional unit of revenue generates more negative working capital, meaning that cashflow grows faster than profit. And that can be reinvested in more growth.

Strengths: Self-funding growth engine. Suppliers effectively provide the capital to run and expand the business. When it works at scale it creates an almost unassailable competitive moat.

Vulnerabilities: A sudden drop in sales doesn't just hurt the P&L, it creates a much larger cash effect, just at the worst time. (A reversal of the growth phenomenon.)

Supplier relationships are the engine. Lose the terms, lose the model. And the model requires constant vigilance on that front; done badly it can lead to bullying smaller suppliers into terms they can’t afford, making the supply chain fragile (and loading hidden costs in).

Discontinuing an unprofitable product line or customer relationship triggers a working capital unwind. It makes it expensive to exit bad commercial arrangements. Flattering cash economics can make you slower to see unprofitable products. Seasonality creates high levels of volatility in cashflow.

KPIs: Inventory turns, DPO, cash conversion cycle, supplier terms, sell-through rate by SKU

Key Levers: SKU count, increased rate of sale per SKU, promotional strategy, lead times, ownership of inventory in transit, safety stock levels by SKU, supplier credit terms, customer deposit and prepayment structures where the model allows, sales volume consistency.

Getting paid by your customers a year ahead sounds like working capital bliss, but if that working capital just unwinds over the next 11 months without being replaced by new subscriptions or renewal, that capital is temporary and therefore has limited use. So structuring of the calendar is key to make deferred working capital work for you.

Industries: SaaS, software licensing, media subscriptions, insurance, maintenance and service contracts, membership businesses, annual retainers, prepaid utilities, gift cards and vouchers

Working Capital Component Mix: Minimal receivables. The dominant balance sheet feature is deferred revenue on the liability side, cash received but not yet earned. In a high-growth phase this balance can be enormous relative to the size of the business.

Relationship With Growth: As long as new bookings and renewals are growing quickly and consistently, this looks a lot like negative working capital. But renewal cycle seasonality means some parts of the year produce larger deferred revenue balances. Meaning often big parts of the deferred revenue balance are temporary more so than structural (limiting how that cash can be deployed).

Multi-year deals add complexity in both directions. Upfront discounts depress the deferred revenue balance. But discounts offered in exchange for larger upfront cash installments accelerate it. The commercial terms and the working capital outcome are inseparable.

Strengths: No credit control to worry about and customers fund the cycle. Visibility of forward revenue is high. Cashflow predictability, when churn is under control, is among the best of any working capital type.

Vulnerabilities: Churn is existential. Beyond revenue impacts, it unwinds the working capital position, creating lumpy and sometimes unexpected cashflow hits. The more evenly spread bookings and renewals are through the year, the smoother the profile. The more they are anchored around fixed dates, the more violent the seasonal swings and response to churn (and growth).

When growth slows, the model stops flattering the cashflow and can often expose weaker unit economics that have been masked by a generous cashflow model.

KPIs: Churn rate, net revenue retention, deferred revenue balance as % of ARR measured at worst month, months of deferred revenue cover, customer acquisition cost payback period, renewal concentration by month.

Key Levers: Churn management, billing frequency and timing, contract length, renewal cycle architecture, discounts for upfront settlement, upsell and expansion revenue timing, refund and cancellation policy.

The biggest challenge with project type working capital cycles is that they are very lumpy, meaning that you become very dependent on large flexible (read: expensive) credit facilities. If you can find a way to match your cash outflows with billing and receipts you can mitigate much of this. So the detail of your contract structure is critical.

Industries: Construction, civil engineering, professional services, defense, infrastructure, IT implementation, film and TV production, shipbuilding, specialist manufacturing to order

Working Capital Component Mix: Dominated by WIP and accrued income on the asset side, with retention receivables adding a long tail. Advance payments from clients can provide meaningful offset where they are achievable. Payables are typically moderate. The net position is almost always positive and often significantly so.

Relationship With Growth: Lumpy and hard to predict. Because sales are made up of a small number of large projects, cashflow is very vulnerable. Working capital builds as projects are won and work commences, then releases (partially) when milestones are billed and cash collected. Retention holdbacks can sit on the balance sheet for years.

Strengths: Revenue is largely contracted and visible. At a portfolio level, the working capital profile is more predictable than it looks project by project. Advance payments, where negotiable, can partially self-fund the cycle.

Vulnerabilities: Cashflow and P&L are structurally divorced. A profitable project can be cash negative for most of its life. Retention ties up capital long after the work is done. Disputes freeze cash at the worst possible moment. Hugely dependent on good debt management.

KPIs: WIP days, retention as % of revenue, billing conversion rate, advance payment coverage, debtor days on billed revenue.

Key Levers: Billing milestone front-loading, billing accuracy, retention negotiation and active chasing, advance payment structures, WIP conversion speed, dispute resolution discipline.

Warren Buffett built the entire Berkshire Hathaway business model off the back of carefully deploying huge, multi-year insurance floats into cash generating assets. Float working capital typically means you have custody of cash that either does not belong to you, or is subject to tight regulation. So finding efficient returns on large long-term cash floats can be the challenge.

Industries: Insurance, reinsurance, regulated payment platforms, property management, travel and ticketing, betting and gaming

Working Capital Component Mix: Minimal own working capital. The balance sheet is dominated by third party funds held in transit or reserve premiums collected, customer deposits, client money. For years (or even - in some cases - decades). The float is available to deploy within regulatory constraints.

Relationship With Growth: Scales directly with volume. More policies = more transactions = more float. The model gets more powerful as it grows.

Strengths: Extraordinarily capital efficient. At scale, the float funds the entire investment portfolio or operating base. Underpins the whole insurance business model.

Vulnerabilities: Entirely dependent on regulatory permission and counterparty trust. The float can reverse overnight. Regulatory compliance is existential.

KPIs: Float days, float as % of transaction volume, cost of float, regulatory capital ratios

Key Levers: Settlement timing, investment of float within regulatory constraints, volume growth, underwriting discipline

Businesses can run multiple working capital profiles shapes on top of each other. Done well, that creates real magic.

Take Secret CFO. Brand partnerships are my primary revenue source, and early on I made a deliberate decision to collect upfront at the point of booking. That’s cost me big opportunities. Some of the biggest names you'd expect to be knocking on my door have been very interested, but you soon reach procurement teams who want 90-day terms post-publishing. I choose to walk away.

A business model choice with real consequences.

But it means no credit control headaches, mutually committed partnerships, and cashflow I can redeploy into building exciting new things for this little pirate ship of ours. This means placing some big bets (you’ll have to wait and see) that have a much hungrier working capital requirement than a brand partnership. One engine funding the other.

In a separate example, I also recently wrote (what is for me) a meaningful equity check into a CPG business, and took a seat on the board. It currently runs a large positive working capital balance, but there's no structural reason it should. When I walked the founder through what a negative cycle would mean for their funding needs as they scaled, and ultimately their dilution - and exactly the steps they needed to take to do it … it blew their mind.

In this case, the business is early enough that we can wire the working capital cycle directly into the operating model while the supply chain is still being designed.

So… how do you deploy all this into your business? Here is some homework:

At the heart of great working capital warfare is a CFO prepared to force hard choices about the business model and the working capital cycle that drives it.

But great design is only half the battle. Executing it well (driving the right levers for the shape of cycle you actually have) is equally important.

Next week, though, we will get into how you fund your cycle.

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Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director, or friend. Well, maybe I’m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need.