The mistake we see most often is treating inventory as a single number on the balance sheet. In reality, it is a stack of SKU-level decisions about service levels, each one committing cash to stock. Add them up and you can hold more inventory than ever while best sellers still run short and slow movers fill the shelves. On paper, current assets look healthy. In the bank, cash is sitting in boxes.
If you have been asked why stock grows while availability falls, a single total does not answer the question. Left as one figure, the discussion usually ends in a blanket cut or another purchase order. Break the total down into days, turns, and safety stock by class, and you can show which products are funding the excess, what each extra point of service costs, and where cash can be released without emptying the shelves that matter.
Does Working Capital Include Inventory? Inventory and Net Working Capital Explained
Yes. Net working capital = current assets – current liabilities, and inventory normally sits within current assets. That is why a larger stockroom can make the balance sheet look stronger while the bank balance gets thinner. Finance sees an asset. You see cash that cannot be spent elsewhere.
Working Capital vs. Inventory: What Is the Difference?
Working capital is the result. Inventory is one of the inputs, alongside receivables and payables. Stock turns into cash only when it is sold and the customer pays, so every unit on the shelf represents cash waiting to be released.
Book value and economic value can also drift apart. Excess, obsolete, or slow-moving stock may be worth less than the figure on the ledger, which is why inventory valuation belongs in any working capital discussion. An asset you cannot sell at cost does not behave like working capital.
How to Measure the Cash Your Inventory Ties Up
Two jobs are easy to confuse. Financial analysis measures how much liquidity inventory absorbs. Operational planning, including forecasts, replenishment, stock levels, and transfers between warehouses, changes that number. Measure first, then act.
Inventory Turnover, Working Capital Inventory Days (DIO) and Carrying Costs
Start with three formulas using figures already available in your accounts:
- Inventory turnover = cost of goods sold ÷ average inventory
- DIO = average inventory ÷ cost of goods sold × 365
- Average inventory = the mean of opening and closing stock at cost for the period
DIO tells you how many days of cost of goods sold are sitting in your warehouse. We cover it in more depth in our guide to days inventory outstanding. There is no universally good number. Compare it with your own previous periods and with your category, not with a textbook benchmark.
Then add the cost of holding that stock. Inventory carrying costs translate days on the shelf into euros per year.
Operating Cycle and Cash Conversion Cycle: A Working Capital Inventory Example
The cash conversion cycle follows the same path: CCC = DIO + DSO – DPO. DSO is the number of days you take to collect from customers, while DPO is the number of days you take to pay suppliers.
The arithmetic is straightforward. If DIO falls by three days while DSO and DPO remain unchanged, the cycle is three days shorter and cash returns three days sooner, every cycle. Be careful with the third lever: stretching DPO also shortens the cycle, but it shifts pressure to the suppliers who control your lead times.
From Service Level to a Working-Capital Number: Safety Stock × Unit Cost by ABC Class
This is the number your planner can hand to finance. For each SKU, the cash held as a buffer is safety stock × unit cost. Sum it by class from your ABC analysis, and you can see which classes are funding the excess. Our guide to safety stock covers the calculation at SKU level.
Here is the shape of the analysis, using rounded numbers to illustrate the method rather than provide benchmarks. Take 10 A-class SKUs with 60 units of safety stock at €20, 30 B-class SKUs with 40 units at €15, and 100 C-class SKUs with 25 units at €8. That gives €12,000, €18,000, and €20,000, or €50,000 in total. The C class, your least important products, holds 40% of the buffer cash.
The relationship between service level and stock is not linear. Under a standard normal distribution, moving a target from 95% to 99% raises the z-factor from 1.65 to 2.33. That means about 41% more safety stock for the same SKU. In the A-class example above, €12,000 becomes roughly €16,900. Higher service targets can cost more than the planner expects, so apply them where margin and demand justify the investment.
The limitation is straightforward: this calculation covers buffer stock only. Cycle stock and in-transit stock also tie up cash, and they are driven by order sizes and supplier lead times rather than service-level targets.
Inventory Management in Working Capital Management: How to Release Cash Without Hurting Service Level
Cutting stock across the board is the quickest way to release cash and the quickest way to lose sales on best sellers. The goal is to move money from products that do not need it to products that do.
Slow Movers, Valuation and Inventory Financing: When Stock Stops Being Liquid
A lower inventory total does not automatically mean more cash. Slow-moving stock that sells only at a discount, or not at all, turns into a write-down rather than a receipt. Releasing that cash may mean accepting a loss against book value, so check valuation before counting the cash as freed.
Judge each class by what it earns on the money it holds. Gross margin return on investment shows whether a product repays the cash parked in it. Where it does not, reduce the buffer, lower order quantities, or sell through the surplus. Where it does, protect the service level and let the rest of the range fund it.
Find Out Whether Your Cash Sits in Buffers or in Order Sizes
Cycle stock and in-transit stock are not included in the safety stock × unit cost calculation because they follow order sizes and supplier lead times. If suppliers impose large minimum order quantities or long lead times, most of your inventory cash may sit there. Lowering service levels on C-class SKUs will then release very little. In that case, start with order sizes and supplier terms, not z-factors.
To see which case you are in, export your SKU list with safety stock, unit cost, and ABC class. Multiply, sum by class, and compare the total with your average inventory at cost. If buffer cash is a small share of average inventory, start with MOQs. If C-class buffers hold a large share, start with service levels.
