Working Capital: How to Free Cash Trapped in Inventory

Every pallet in the warehouse is money that has already been spent and not yet earned back. For product businesses, inventory is usually the largest and most neglected source of working capital. Treated carefully, it can fund growth without a new loan; ignored, it quietly consumes the cash the business needs to operate.

Cash trapped on shelves

When you buy stock, cash leaves immediately. It returns only when the item is sold and the customer pays. Between those points sit storage, insurance, handling and the risk of obsolescence. A product that sells slowly at a healthy margin can be worse for cash than a fast seller at a thin margin.

Owners often measure inventory by value at cost, which hides the problem. A warehouse full of slow-moving items looks like an asset on the balance sheet, but it may never convert at the price assumed. The useful question is not how much stock you hold but how long each item will take to turn into cash.

Measure inventory days and DIO

Inventory days, also called days inventory outstanding, is average inventory divided by cost of goods sold, multiplied by 365. If the result is 120 days, you are financing four months of stock. Track it monthly and split it by category, because an overall average can hide one category that is stuck.

Pair the measure with sell-through and gross margin by product. A high-margin item can justify a longer hold; a low-margin item with the same days is simply expensive. This combination shows where cash is being consumed and which products earn the right to sit on a shelf.

Related reading: the invoice finance decision pairs well with Invoice Financing and Factoring.

Segment stock by movement

Divide inventory into four groups: fast movers, steady sellers, seasonal lines and dead stock. Fast movers deserve tight availability targets because a stockout costs revenue. Steady sellers can be replenished more frequently. Seasonal lines need a plan for the end of the season, and dead stock needs a decision, not another year of storage.

Set different policies for each group rather than one blanket reorder rule. Fast movers might be reviewed weekly, slow movers monthly. The aim is to hold enough to protect sales without treating every item as equally important. Many businesses find that a small share of SKUs generates most of the cash tied up.

Inventory is cash wearing a disguise. The only question that matters is how long the disguise lasts.

Negotiate terms with suppliers

Payment terms are working capital. Extending terms from 30 to 60 days on a large supplier is equivalent to an interest-free loan for a month. Ask during contract renewal, when you have the most leverage, and offer something in return such as a firmer forecast or a slightly larger order.

Be realistic about what you can commit to. A supplier who agrees to longer terms but then receives late payments will raise prices or reduce priority. If you can pay early, ask for a discount instead. Compare the annualised value of the discount with the cost of your credit line before deciding which is better.

Also see our guide to the 13-week cash flow routine for a deeper comparison.

Pre-orders and deposit structures

If your market allows it, take deposits or pre-orders for new lines. Customer cash can fund production and reduce the amount you need to borrow. This works best when delivery dates are credible and communication is clear; a deposit taken for a product that arrives months late damages trust more than it helps cash.

For custom or made-to-order work, stage payments are standard. Structure them to cover materials before you commit, labour during production and margin on delivery. A simple three-stage schedule is easier to administer than many small invoices, and it keeps the cash cycle closer to the work cycle.

Background: how working capital is defined.

Financing the gap

If stock is genuinely needed and the cash gap is temporary, short-term finance can be cheaper than losing sales. A revolving credit facility, inventory finance or supplier credit may bridge the gap. Compare the cost with the gross margin the stock will generate, not with the bank rate alone.

Avoid using long-term debt to fund permanent inventory levels unless the business has stable, predictable demand. If the stock does not sell as planned, the debt remains. A useful rule is that financing should cover timing, not unsold goods. If the inventory is not moving, the answer is a pricing or assortment decision, not more borrowing.

A quarterly cash release routine

Once a quarter, list every SKU with its quantity, age, cost and last sale date. Flag anything older than your normal cycle, calculate the cash tied up and decide: discount, bundle, return to supplier or write off. Set a target for cash released and track it like a sales target.

Then review the causes. Over-ordering from a minimum order quantity, optimistic launch forecasts and duplicate variants are common culprits. Adjust the buying rules so the same stock does not rebuild. Freeing cash once is useful; changing the process is what keeps working capital healthy.