What it means
Businesses have limited money, and much of it is tied up in day-to-day operations. Cash may be locked in unsold stock, unpaid customer invoices, deposits or old equipment.
When any of this is reduced, the money is released and can be spent on something else, which is what people mean when they say funds are freed up. A common source is working capital, the money needed to run the business from day to day.
If a company collects payments from customers faster, holds less stock or pays suppliers more slowly within agreed terms, it needs less cash to operate. The difference is cash freed up that can be used to repay debt, invest or return money to owners.
Cost savings produce a similar effect. If a company renegotiates a contract and saves $50,000 a year, that money is freed up for other purposes.
Selling an unused building or retiring a loan also releases funds and removes obligations. The wording needs some care.
Freed-up cash is only useful if it is really available and not already committed to something else. A one-off release, such as collecting old invoices, is also different from a permanent saving that repeats each year.
Managers use the concept when they build business cases. A project that frees up cash can be presented as a funding source for another initiative, and lenders like to see that a business can create its own capacity.
Clear numbers and timing make the claim credible. It is also worth separating the cash that is released from the benefit that follows.
Releasing $150,000 from stock creates value only when the money is put to work, for example by cutting an overdraft that costs 10% a year or funding a project that earns more than that.
In practice
Real-world examples.
Example
A distributor cuts its stock from 90 days to 70 days of sales. The warehouse holds less product, and about $200,000 of cash that was sitting on the shelves is freed up to pay down a bank overdraft. The overdraft interest saved is a further gain from the release.
Example
A software company moves its offices to a cheaper location and saves $8,000 a month. Over a year, $96,000 is freed up and the finance director allocates it to developing a new product. The finance director records the benefit over twelve months.
Example
A farmer sells an old tractor that is no longer needed for $25,000. The money is freed up to put a deposit on a more efficient machine and to reduce interest costs. The farmer also saves insurance and storage costs on the old tractor.
Formula
Calculation
Cash freed up = daily sales x reduction in days sales outstanding
Suppose a company has annual sales of $3,650,000, so daily sales are $3,650,000 / 365 = $10,000. It currently takes 60 days to collect payment from customers, and a new collection process reduces this to 45 days.
The reduction is 60 - 45 = 15 days. Cash freed up = $10,000 x 15 = $150,000, which is a one-off release of cash tied up in unpaid invoices.Case study
Seen in the real world.
Stonebridge Wholesale is a fictional distributor that was short of cash despite being profitable. Its finance manager studied the numbers and found that customers were paying in an average of 65 days, while the company was paying its own suppliers in 40 days. The gap meant it had to borrow to fund 25 days of sales.
She introduced early payment discounts and sharper reminders. In this illustrative scenario, the average collection period fell to 50 days, which, at daily sales of $12,000, freed up $180,000 of cash.
The business used that cash to pay off a short-term loan that cost 9% a year and saved about $16,200 a year in interest. The managing director later told the staff that improving collection was like finding money in the warehouse.
Watch out
Common mistakes.
- Counting freed-up cash that is already committed elsewhere, which makes the benefit look larger than it is.
- Treating a one-off release of working capital as if it were a repeating saving.
- Freeing up cash by squeezing suppliers so hard that relationships or supply are harmed.
Questions
People also ask.
Is freed-up cash the same as profit?
No. Freed-up cash comes from changes in what the business holds or owes, while profit comes from earning more than it spends. A business can have healthy profits and still be short of cash if too much is tied up.
Where does freed-up cash usually come from?
Common sources are faster collection from customers, lower stock levels, cost cuts, asset sales and reduced debt payments. Each source has a different level of permanence, so managers should note which ones can be repeated.
Can freed-up resources include time?
Yes. Staff hours saved by automation are often described as freed up, and they can be redirected to higher-value work. Time saved only has value if it is actually used for something more productive.
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