How to manage working capital in a trading or distribution business

Trading and distribution businesses have working capital dynamics that are different from service or manufacturing businesses — you're buying to hold and selling with payment terms, which means your working capital requirement is primarily driven by inventory levels and the difference between how long you hold stock and how long your customers take to pay you.

The working capital cycle in distribution: you pay your supplier (cash out), hold inventory (cash tied up), sell to a customer (inventory converts to receivable), and collect payment (cash in). Your working capital requirement is the total of what's tied up in inventory plus receivables, minus what you owe suppliers. Every day you reduce the inventory holding period or the collection period, or every day you extend supplier payment terms, reduces your working capital requirement.

Inventory turns is your most important metric. Calculate: annual cost of goods sold / average inventory value. If your inventory turns 4 times per year, you're holding 90 days of stock on average. If you can improve to 6 turns, you're holding 60 days — a 33% reduction in inventory working capital. Most trading businesses have significant room to improve inventory turns through better ordering discipline and dead stock management.

Customer credit risk is a constant challenge in distribution. You're extending credit to retailers or customers who may not always pay reliably. Build a credit policy: define credit limits for each customer based on their size, payment history, and your risk tolerance. Don't extend credit beyond the limit without specific approval. Consistently enforce consequences (stop supply) for customers who exceed their payment terms.

Distributor of large brand: if you're a distributor for a large brand, the principal controls your payment terms to the brand and often expects you to extend credit to your sub-distributors or retailers. This squeeze — paying the principal quickly and collecting from retailers slowly — is the primary working capital challenge of Indian distribution businesses. Negotiate with both sides.