Working Capital Management for New CEOs

Working capital is the lifeblood of any business, but it is especially critical in search fund acquisitions where the new CEO is managing a leveraged company with debt service obligations. Poor working capital management is one of the most common reasons otherwise profitable businesses run into cash flow crises. The good news is that working capital optimization is one of the most accessible value creation levers available to a new CEO — improvements often require process changes, not capital investment, and the results flow directly to free cash flow and debt paydown capacity.

Understanding the cash conversion cycle

The cash conversion cycle (CCC) measures how many days it takes to convert a dollar invested in inventory and operations back into cash. The formula is straightforward:

CCC = DSO + DIO − DPO

• Days Sales Outstanding (DSO): the average number of days it takes to collect payment from customers after a sale. Lower is better.
• Days Inventory Outstanding (DIO): the average number of days inventory sits before being sold. Lower is better.
• Days Payable Outstanding (DPO): the average number of days you take to pay your suppliers. Higher is better (within reason).

A business with 45-day DSO, 30-day DIO, and 30-day DPO has a 45-day cash conversion cycle. Every day you shorten the cycle frees up cash. For a $10M revenue business, reducing the CCC by 10 days frees up approximately $274K in cash ($10M / 365 x 10 days).

Accounts receivable management

Accounts receivable (AR) is typically the largest working capital opportunity in acquired SMEs. Many small businesses have lax collection practices — invoices go out late, payment terms are generous, and past-due balances accumulate without follow-up.

Aging analysis

The first step is to run an AR aging report and categorize all outstanding invoices by age: current, 1–30 days past due, 31–60 days, 61–90 days, and 90+ days. This report will reveal the scope of the problem and identify specific customers who are chronically late payers.

• Current and 1–30 days past due: normal business operations. Monitor but do not panic.
• 31–60 days past due: escalate to personal phone calls from the billing team or account manager. Understand the reason for delay.
• 61–90 days past due: escalate to management. Consider stopping new work or shipments until the balance is resolved.
• 90+ days past due: these balances have a significantly reduced probability of collection. Engage collections or negotiate a settlement.

Collection process improvements

• Invoice immediately. Many SMEs wait days or weeks after completing work to send invoices. Invoice on the day of delivery or project completion.
• Electronic invoicing.Switch from mailed invoices to email with PDF attachments. Include a link to pay online via ACH or credit card. This alone can reduce DSO by 5–10 days.
• Automated reminders. Set up automated email reminders at 7 days before due, on the due date, and at 7, 14, and 30 days past due. Most accounting software supports this natively.
• Dedicated AR person. If AR exceeds $500K, dedicate at least a part-time person to collections. Their cost will be recovered many times over in faster collections and reduced bad debt.

Payment terms optimization

• Review all customer payment terms. Many SMEs offer Net 30 by default but have never tested Net 15 or payment on receipt.
• Offer early payment discounts (e.g., 2/10 Net 30 — a 2% discount for payment within 10 days). This effectively costs you 36% annualized, so use it selectively for large, slow-paying customers where the cash flow benefit outweighs the cost.
• For new customers, start with shorter payment terms and extend them only as the relationship and credit history are established.
• Require deposits or progress payments for large projects. A 25– 50% deposit upfront dramatically reduces working capital needs on project-based work.

Inventory optimization

For businesses that carry physical inventory, optimization can free up significant cash without impacting service levels. Many SMEs carry too much inventory because ordering is done reactively rather than systematically.

ABC analysis

Categorize inventory items into three groups based on revenue contribution:

• A items (top 20% of SKUs, ~80% of revenue): these are your critical items. Maintain appropriate safety stock, monitor daily, and optimize reorder points based on demand forecasting.
• B items (next 30% of SKUs, ~15% of revenue):moderate attention. Review weekly, maintain reasonable stock levels, and use standard reorder quantities.
• C items (bottom 50% of SKUs, ~5% of revenue):these are candidates for reduction or elimination. Many SMEs carry hundreds of slow-moving SKUs that consume warehouse space and tie up cash. Liquidate dead stock and consider make-to-order or drop-ship models for low-volume items.

Safety stock and just-in-time considerations

• Calculate safety stock based on demand variability and supplier lead times, not gut feeling. Most SMEs significantly overstock because they fear stockouts.
• Negotiate shorter lead times or consignment arrangements with key suppliers. If a supplier can deliver in 3 days instead of 14, you need less safety stock.
• Implement a perpetual inventory system if one does not exist. You cannot optimize what you cannot measure. Even a simple barcode scanning system ($5K–$15K) pays for itself in reduced shrinkage and better ordering decisions.
• Just-in-time (JIT) is ideal but risky for SMEs with limited supplier diversification. Adopt JIT principles selectively for high-volume, reliable-supply items while maintaining buffers for critical or single-source components.

Accounts payable strategy

While AR and inventory are about accelerating cash inflows and reducing cash tied up in operations, accounts payable (AP) is about strategically managing cash outflows. The goal is not to pay late or damage supplier relationships — it is to use your full payment terms effectively and negotiate better terms where possible.

Negotiating supplier terms

• Review all supplier payment terms. If you are paying on receipt or Net 15 by default, negotiate for Net 30 or Net 45.
• Use your increased purchasing power (especially in a buy-and-build strategy) to negotiate better pricing and longer payment terms simultaneously.
• Consolidate suppliers where possible. Concentrating spend with fewer vendors gives you negotiating leverage.
• Do not stretch payments beyond agreed terms without communication. Damaging supplier relationships creates risk: delayed shipments, lower priority during shortages, and potentially losing key vendors.

Early payment discounts

• If a supplier offers 2/10 Net 30, paying early earns you an annualized return of approximately 36%. If you have the cash, take the discount — it is one of the highest-return investments available.
• Set up your AP system to flag early payment discount opportunities automatically.
• If you do not have the cash for early payment, consider using a supply chain financing platform that pays the supplier early (capturing the discount) while extending your effective payment terms.

Cash flow forecasting: the 13-week model

The 13-week cash flow forecast is the most important financial management tool for a newly acquired business. It provides a rolling three-month view of cash inflows and outflows, allowing you to anticipate shortfalls, time major expenditures, and manage your line of credit proactively.

• Build the model week by week, not month by month. Weekly granularity catches timing issues that monthly forecasts miss.
• Include all cash inflows: customer collections (based on AR aging and payment patterns, not when revenue is booked), deposits, other income, and line of credit draws.
• Include all cash outflows: payroll, rent, supplier payments, debt service, taxes, capital expenditures, and any one-time expenses.
• Update the forecast weekly. Compare actual results to the forecast and refine assumptions. After 8–12 weeks, your forecast accuracy will improve significantly.
• Share the forecast with your board and lenders. Transparency builds trust and gives them confidence in your financial management.

Working capital as a source of value creation

Working capital improvements are one of the most underappreciated value creation levers in search fund acquisitions. Here is why they matter so much.

• Free cash flow impact. Every dollar freed from working capital is a dollar of free cash flow that can be used to pay down debt, fund growth, or distribute to investors.
• Debt capacity. Lower working capital needs improve cash flow coverage ratios, potentially allowing you to negotiate better debt terms or take on additional leverage for add-on acquisitions.
• Valuation impact. Buyers and investors value businesses with efficient working capital management. A business that generates strong free cash flow relative to EBITDA commands a premium multiple.
• Compounding returns. Working capital improvements are permanent. A 10-day reduction in DSO benefits you every year, not just the year you implement it.

Seasonal working capital needs

Many SMEs have seasonal revenue patterns that create predictable working capital peaks and troughs. Understanding and planning for these cycles is essential.

• Map the seasonal pattern: when does revenue peak and trough? When do you need to build inventory? When are cash collections highest and lowest?
• Build seasonal adjustments into your 13-week forecast and annual budget.
• Use your line of credit to smooth seasonal fluctuations, drawing during peak working capital periods and paying down during cash-rich periods.
• Consider offering seasonal promotions or incentives to shift demand to off-peak periods and smooth revenue throughout the year.

Line of credit management

A revolving line of credit (revolver) is an essential tool for managing working capital fluctuations. Most search fund businesses should have a revolver in place from day one.

• Size the facility at 10–15% of annual revenue or one to two months of operating expenses, whichever is larger.
• Negotiate the revolver as part of your acquisition financing. Lenders are more receptive to revolver requests when they are part of a broader lending relationship.
• Monitor your borrowing base (if the revolver is asset-based). Stay well within your availability to maintain a cushion for unexpected needs.
• Use the revolver for timing mismatches, not to fund operating losses. If you are drawing on the revolver and it is growing month over month, you have a profitability problem, not a working capital problem.

Common working capital traps in acquired businesses

• The owner's personal guarantees.Suppliers may have extended terms based on the previous owner's personal credit and relationships. When ownership changes, suppliers may tighten terms, creating an unexpected cash crunch. Proactively communicate with key suppliers and establish your own credit relationships.
• Hidden AR issues. The previous owner may have allowed large balances to accumulate with long-time customers as a relationship gesture. You inherit these balances and the awkward task of collecting them.
• Obsolete inventory. The balance sheet shows $500K in inventory, but $150K of it is obsolete, slow-moving, or unsellable. This inflates the working capital peg in the purchase agreement and saddles you with deadweight inventory.
• Deferred maintenance. The previous owner may have reduced capital expenditures in the years before the sale to boost EBITDA, creating a backlog of deferred maintenance that requires significant cash outlay after closing.
• Working capital adjustment disputes.The working capital peg in your purchase agreement defines the “normal” level of working capital the seller should leave in the business. Disputes over this calculation are extremely common. Engage your accountant early and monitor working capital closely between signing and closing.

Quick wins in the first 90 days

1. Run an AR aging report and personally call every customer with a balance over 60 days past due. Collect what you can and understand why payments are delayed.
2. Switch to electronic invoicingwith online payment options. This alone typically reduces DSO by 5–10 days.
3. Review inventory and identify the bottom 20% of SKUs by velocity. Liquidate dead stock and stop reordering slow-moving items.
4. Negotiate payment terms with your top five suppliers. Even a 15-day extension on your largest vendors creates meaningful cash flow improvement.
5. Build a 13-week cash flow forecast and review it weekly with your controller or CFO. This is your early warning system.
6. Set up a revolving line of credit if one does not exist. Even if you do not need it today, having it available provides critical flexibility.

Working capital management is not glamorous, but it is one of the highest-impact activities a new CEO can undertake. The cash freed by better AR, inventory, and AP management often equals or exceeds the annual debt service on the acquisition loan — effectively funding the deal from operational improvements alone.