Course contents
Practitioner · Course 4: Working Capital and the Cash Cycle · Lesson 1 of 5

What working capital measures and why a growing factory can still run short of cash

Level: PractitionerTime: 45 minutesOrder used: A (the T-shirt, Northline Apparel export order)Tool: Working capital and cash cycle sheet
This lesson is for a factory owner, a production manager, or a finance clerk who needs to know why cash and profit differ. You need lesson T01-C07-L04 on payment terms and cash flow. Figures are teaching examples in US dollars; at work, use your own factory's own numbers.
FactoryDelta Garments
Export orderOrder A, Northline Apparel, 15,000 T-shirts, letter of credit
Order valueUSD 48,000 (15,000 x USD 3.20)
Order profitUSD 3,900 (USD 0.26 per piece)
Production period70 days, from approvals to shipment
What this lesson measuresThe cash a factory needs on hand while it waits to be paid
02Opening

This page explains why a factory can be busy, profitable, and still unable to pay its own bills on time

This page is for a factory owner, a production manager, or a finance clerk who has to explain why a factory winning orders and making a profit on each one can still find cash tight. At work, a merchandiser or an owner often looks at a full order book and assumes the factory's cash position must be healthy too. It is not the same thing. This lesson mainly teaches the money flow: it separates the profit an order earns from the cash a factory must hold while that order is still being made and paid for.

Delta Garments runs Order A for Northline Apparel: 15,000 T-shirts worth USD 48,000, earning a real profit of USD 3,900. That profit is genuine. But between buying fabric and being paid, Delta Garments must fund the whole USD 48,000 out of its own pocket, or borrow it, for as long as the order takes to complete and be paid for. Without this skill, a factory grows its order book without checking whether it can actually fund the cash gap that growth creates, and can run short of cash even while every single order is profitable.

03Before you start

What you need, and what this lesson does not cover

You need: the idea of a cash-flow gap and payment terms from lesson T01-C07-L04. You do not need any accounting qualification.

By the end of this lesson you can:

  • define working capital as current assets minus current liabilities;
  • explain why an order's profit and the cash it ties up are two separate amounts;
  • name the two things a factory's cash is tied up in before it is paid: inventory and unpaid customer invoices;
  • explain why taking on more orders at once can increase, not reduce, a factory's cash shortage;
  • avoid assuming a full order book means a healthy cash position.

Not covered here: how to calculate the exact number of days cash is tied up (lesson T15-C04-L02), how to shorten that wait (lesson T15-C04-L03), and how a specific order's own payment terms change the picture (lesson T15-C04-L04).

04Key terms

Words you will meet in this lesson

TermMeaning
Working capitalThe money a business needs on hand to keep operating while it waits to be paid for goods already made.
Cash flowThe movement of money into and out of a business over time, separate from how much an order is worth on paper.
Cash-flow gapThe length of time between a factory finishing production and actually receiving payment for that production.
ProfitThe money left over after all costs are paid, out of a selling price.
Letter of creditA bank promise to pay the factory once the shipping documents match the order.
Open accountA payment method where the buyer pays the factory an agreed number of days after delivery, with no bank guarantee in between.
05Teaching
The rule

Working capital is current assets minus current liabilities, and it measures cash tied up, not profit earned

Working capital is a standard accounting measure: current assets minus current liabilities. For a garment factory, current assets are mostly fabric and trims not yet used, garments in production or finished but not shipped, and invoices sent to buyers but not yet paid. Current liabilities are mostly unpaid supplier invoices and any short-term loans. The difference between the two is the cash a factory must have, or borrow, to keep its operations running while orders move through the factory and through the buyer's payment process. Working capital is never the same number as an order's profit, and confusing the two is the most common cash-planning mistake a growing factory makes.

Working capital = Current assets - Current liabilities
What you meet in real life

Working capital pressure shows up differently depending on how a factory sells, who it sells to, and how fast it grows

A merchandiser meets several different shapes of this same pressure across a normal working week, and learning to recognise each one prevents a costly assumption from creeping into a cash-flow plan.

What can differThe shapes you will meetWhy it matters
Export order paid by letter of creditDelta Garments funds Order A's whole USD 48,000 cost from fabric purchase until the letter of credit pays out at shipment.Even a fast-paying export term still leaves a real gap between spending cash and receiving it.
Domestic order on open accountAn equivalent-value domestic order for Cedar & Co. is paid 60 days after delivery, on top of the production period.A slower payment term enlarges current assets (unpaid invoices) for longer, raising the working capital need for the same order value.
A factory taking on more orders at onceDelta Garments accepts two Order-A-sized orders in the same season instead of one.Current assets roughly double at the same time; the cash needed to fund them does too, even though each order is separately profitable.
Make to Order versus Make to StockA Make to Order factory like Delta Garments only builds inventory against a confirmed order; a Make to Stock brand builds inventory ahead of confirmed sales, from its own forecast.A Make to Stock business can carry inventory for longer before any sale exists at all, which is its own separate working capital pressure.
The case we follow

Delta Garments looks profitable on Order A but must still fund the whole order before being paid

Delta Garments' Order A earns a real profit of USD 0.26 per piece. But profit is only what is left over once the order is finished and paid for. Long before that point, Delta Garments has already spent cash on fabric, trims and labour for all 15,000 pieces, and that spent cash sits inside the factory first as raw fabric, then as cut and sewn garments, then as finished goods waiting to ship, then as an unpaid invoice to Northline Apparel, until the letter of credit finally pays out. During that whole stretch, what Delta Garments owns that will soon turn into cash is higher, and its own cash on hand is lower, than its finished profit figure would suggest.

Fabric andtrims boughtCut and sewngarmentsFinished goodsawaiting shipmentUnpaid invoiceto Northline Apparel
Cash spent on Order A passes through four stages before it returns as cash in hand. At every stage it is money Delta Garments has already spent but not yet recovered.
The worked number

Order A's profit is a small share of the cash actually tied up while the order is in progress

Order value: 15,000 x 3.20 = USD 48,000
Order profit: 15,000 x 0.26 = USD 3,900
Share of the tied-up cash that is actually profit: 3,900 / 48,000 = 8.1%
Order A: cash tied up compared with profit earnedProfit USD 3,900 (8.1%)Full order value tied up, USD 48,000
Profit is a thin slice of the cash a factory must fund. The other 91.9% of Order A's value is cash Delta Garments must find from somewhere before it is repaid at shipment.
The method

Four steps to check whether a full order book actually means healthy cash

  1. List every order currently in production or awaiting payment.
  2. Add up each order's own value, not its profit, since value is the cash tied up.
  3. Estimate how long each order's cash stays tied up, from first spending to final payment.
  4. Compare the total cash tied up across all orders at once against the cash the factory actually has or can borrow.
The trap

A common mistake is judging a factory's cash health from its order book alone

A common mistake is assuming a factory with a full order book and profitable pricing must have healthy cash. Profit is only realised once an order is finished and paid; until then, its full value sits as cash tied up, not cash in hand. A factory that wins three profitable orders at once, each needing its own fabric purchase and labour cost paid up front, can find itself needing far more cash at one time than it holds, even though every order will eventually turn a profit. Growth makes this trap worse, not better: a factory that doubles its order book without changing its payment terms or its own supplier credit roughly doubles the cash it must find at the same time, long before any of that growth shows up as extra profit in the bank. What this costs a factory that gets it wrong is real: an unplanned cash shortage can force it to delay paying its own suppliers, borrow at short notice, or turn down a new order it could otherwise have made money on, precisely at the moment its business looks most successful on paper.

06In plain words

A factory's profit and its cash are not the same thing. Profit is what is left over once an order is fully finished and paid. Working capital is the cash a factory must hold, or borrow, while an order is still moving through production and waiting to be paid. Fabric bought, garments made, and invoices sent but not yet paid all count as cash tied up, even though none of it is profit yet. A factory that takes on more orders at once needs more of this tied-up cash at the same time, not less, even if every order is separately profitable. A full order book is good news for future profit. It is not proof that a factory's cash position is healthy right now.

07Quick check
  • Working capital equals current assets minus current liabilities.
  • An order's profit is often less than 10% of the cash a factory must tie up to complete it.
  • Inventory and unpaid customer invoices are a factory's own current assets.
  • Taking on more orders at once increases the total cash tied up, even when each order is profitable on its own.
  • A full order book says nothing on its own about whether a factory can fund its own cash needs.
  • Make to Stock brands carry inventory even before a sale exists, adding a further working capital pressure of their own.
08Workplace scenario

Karim reports a full order book to Delta Garments' owner, who assumes cash must therefore be healthy

Delta Garments has just confirmed two new export orders of similar size to Order A, on top of the order already in production. Karim, the production manager, reports this to the owner as good news. The owner reads the report and tells the finance clerk there is no need to check the bank balance this month, since three profitable orders are now confirmed.

Here is the note Karim actually wrote:

Production report, this week. Orders currently in production or awaiting payment: 3, each of similar value to Order A (about USD 48,000). Combined order value in progress: about USD 144,000. Combined profit expected once all three are paid: about USD 11,700. Cash currently held by the factory: not stated in this report.

Is the owner right that a full, profitable order book means the factory's cash position needs no further check? Decide before opening the answer.

Show decision

No. Two facts in Karim's own report decide this together.

First, the size of the cash tied up. About USD 144,000 of order value is now in progress at once, most of it not yet spent on fabric and labour that must still be paid for. That is more than 12 times the USD 11,700 of profit the three orders will eventually earn.

Second, what the report does not say. Karim's report never states how much cash Delta Garments currently holds or can borrow. Without that number, nobody can tell whether USD 144,000 of cash tied up at once is comfortably affordable or a serious risk.

The owner's instinct that three profitable orders is good news is correct. But good news about future profit is not the same question as whether the factory can fund USD 144,000 of cash tied up right now. The finance clerk should still check the bank balance before assuming the cash position is safe.

09What it costs

What happens when a factory funds a growing order book without checking its own cash

Using Order A's own figures scaled to three orders in progress at once, as in Karim's report:

Combined order value in progress: 48,000 x 3 = USD 144,000
Combined profit once all three are paid: 3,900 x 3 = USD 11,700
Cash tied up for every USD 1 of eventual profit: 144,000 / 11,700 = about USD 12.30

For every dollar of eventual profit, Delta Garments must fund about USD 12.30 of cash tied up while the orders are in progress. If the factory cannot fund or borrow that amount, it may have to delay paying Nile Spinning or Colorline Dyeing for fabric already delivered, which risks losing supplier trust on the very next order, a cost that does not show up on any single order's own costing sheet.

10Working template

Working capital and cash cycle sheet: record what is tied up before you check what it earns

Open the course workbook's "Working capital" sheet. It lists current assets (inventory, unpaid customer invoices) and current liabilities (unpaid supplier invoices, short-term loans) as separate rows, and calculates working capital as their difference with a live formula. For Order A, enter the order value as inventory or receivable, depending on its stage, and leave the profit figure out of this sheet entirely; profit belongs on the costing sheet, not on the working capital sheet.

[Download the Working capital and cash cycle sheet](../../templates/T15-C04-working-capital-and-cash-cycle-sheet.xlsx)

Download the Working capital and cash cycle sheet (Excel)

11Check yourself

1. What is working capital?

2. Why can a factory with a full, profitable order book still run short of cash?

3. A factory takes on two new orders of USD 30,000 each at the same time, each earning USD 2,000 profit. What happens to its working capital need compared with running one such order at a time?

12Glossary
ENARFRTRMeaning
Working capitalرأس المال العاملFonds de roulementİşletme sermayesiThe money a business needs on hand to keep operating while it waits to be paid for goods already made.
Cash flowالتدفق النقديTrésorerieNakit akışıThe movement of money into and out of a business over time, separate from how much an order is worth on paper.
Cash-flow gapفجوة التدفق النقديÉcart de trésorerieNakit akışı açığıThe length of time between a factory finishing production and actually receiving payment for that production.
ProfitالربحProfitKârThe money left over after all costs are paid, out of a selling price.
Letter of creditاعتماد مستنديLettre de créditAkreditifA bank promise to pay the factory once the shipping documents match the order.
Open accountحساب مفتوحCompte ouvertAçık hesapA payment method where the buyer pays the factory an agreed number of days after delivery, with no bank guarantee in between.
13Next

Lesson 4.2: Calculating a factory's own cash conversion cycle from its real operating days

You now know why working capital and profit are different amounts. The next lesson breaks the wait for cash into three named parts and shows you how to calculate the total number of days a factory's cash stays tied up. Back to the course map

14Ladder

RecognizeTell an order's profit apart from the cash it ties up while in progress.
ConnectSee why current assets and current liabilities, not profit, define working capital.
CompareWeigh a single order's cash needs against several orders running at once.
DecideJudge whether a full order book proves a factory's cash position is healthy.