What is working capital?
Working capital requirement (WCR ) is a strategic accounting indicator for a company's development.
A definition of working capital requirements (WCR)
The working capital requirement is the amount a company needs to finance to cover its needs between cash flow shifts: book entries and outflows.
It is the difference between :
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Current assets: inventories, trade receivables, etc.
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Current liabilities: accrued expenses, trade payables, etc.
A company that has to pay its suppliers before receiving payment from its customers has a working capital requirement that needs to be financed. Working capital requirements are likely to be significant if inventories and lead times are long.
The differences between current assets and current liabilities
How do you calculate a company's WCR?
The formula for calculating WCR for a company is as follows:
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WCR = current assets - current liabilities
In detail, to calculate a company's working capital requirement, we need to perform the following operation:
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WCR = (inventories + trade receivables + tax receivables) - (trade payables + tax and social security liabilities)
A company's working capital requirement can be positive, zero or negative. Knowing how to interpret WCR is essential for any entrepreneur.
What is positive WCR?
Positive WCR is an important indicator of the financial health of a company's cash position.
Positive WCR: a warning to take into account for your company's operations
Positive WCR is a financial indicator stating that a company is obliged to finance its current operations before receiving payment from its customers. Assets exceed liabilities. The company invests mainly in short-term assets. At the same time, it has few short-term supplier credits.
Positive WCR: cash flow problems
A company's positive WCR may reveal solvency problems, or even dependence on external financing. To avoid a positive WCR, an entrepreneur must pay close attention to operating cycles:
- trade payables ;
- trade receivables ;
- strategic stocks, etc.
Devising strategies to boost positive WCR
A positive WCR does not represent a comfortable financial situation for entrepreneurs. They need to devise strategies to meet the company's working capital requirements before customers are cashed in.
To this end, it is possible to increase capital by injecting additional funds from shareholders. Another solution is to use bank loans to maintain an optimal level of liquidity.
What is zero WCR?
Zero WCR indicates a balance between current liabilities and current assets. The company's cash flows are balanced. Zero working capital means no surplus to invest. The company's net cash position is zero. Revenues are sufficient to cover expenses.
What is negative WCR?
A company's negative WCR is an indicator of healthy cash flow.
Negative WCR: cash flow in good working order
Negative WCR means that a company has internal financing resources to run its operating cycle. Negative WCR is generated when current liabilities exceed current liabilities. In other words, the company receives payment from its customers before it pays its suppliers.
Reduce the need for external funds
A positive WCR enables a company to reduce its need for external financing to complete its operating cycles.
Surplus cash is generated by two factors:
- of suppliers with extended supplier payment terms ;
- immediate customer receipts.
The cash surplus resulting from a negative WCR offers greater flexibility in the day-to-day management of the company's operations.
Forecasting working capital requirements: normative WCR
Working capital can be an indicator of your company's development strategy. SeDomicilier presents an indispensable tool for optimizing your cash flow: the normative WCR.
Operating working capital requirement (OWR) and normative WCR
WCR can be converted into a number of days' sales. This operation calculates the proportion of daily sales to be devoted to working capital. This is the normative WCR.
The operating working capital requirement (OWCR) is a key factor in managing a company's cash flow. It measures cash requirements over a given period, taking into account the time lag between three elements:
- collection times for trade receivables ;
- the company's inventory turnaround times ;
- payables disbursement periods.
Operating WCR is calculated retroactively. It is recorded in the company's balance sheet.
Conversely, normative WCR quantifies a company's needs to finance its operating cycle over the coming period. This indicator is forward-looking.
How do you calculate normative WCR?
Before calculating normative WCR, it is necessary to select the normative level of operating working capital items.
Calculation of normative WCR = normative inventories + normative operating receivables - normative operating payables.
The calculation of the normative WCR represents a forward-looking complement to the BFRE. Entrepreneurs can use this strategic indicator to fine-tune their control of items with an impact on the company's working capital requirements.
Determining normative WCR enables you to fine-tune your development strategy by determining your cash flow requirements to finance your company's operating cycle.
Why calculate a company's WCR?
Determining an organization's working capital requirements is essential to maintaining a healthy cash position .
Know your additional financing needs
Calculating working capital requirements in detail enables you to anticipate the cash resources needed for the company to carry out its operating cycles. Calculating WCR determines any external and internal financing requirements needed to keep cash flowing.
Managing working capital
The calculation of WCR helps to reduce the level of working capital requirements by paying particular attention to normative items:
- inventories ;
- receivables ;
- debts.
Working capital is a lever for financing shortfalls between customer receipts and supplier disbursements. Optimal management of WCR involves negotiating payment terms with your suppliers that are long enough to enable you to collect from your customers in advance.
Anticipating cash flow
Calculating WCR enables you to manage your cash flow and anticipate any shortfalls. In this way, entrepreneurs reduce the risk of a drop in funds available to finance their operating cycles.
Entrepreneurs need to be able to measure the sources of discrepancies in their cash flow. These gaps can be reduced by adopting specific strategies.
Optimizing customer assets on the balance sheet
A company's outstanding receivables represent an opportunity to optimize working capital requirements. There are a number of steps you can take to implement this strategy:
- Reduce your customers' payment times to reduce cash flow shortfalls.
- Ask for a deposit at the time of order to obtain part of the payment from your customers.
- Impose shorter payment terms for new customers.
- Introduce late payment penalties and discounts to encourage customers to pay their invoices on time.
- Optimize your invoicing process for more efficient processing of your customers' invoices.
Optimizing trade payables: operating debts
By increasing your suppliers' payment times, you can optimize your working capital requirements. The pillars of this strategy are as follows:
- Increase your suppliers' payment terms as much as possible;
- Choose suppliers with payment terms of 60 days or less.
- Negotiate advantageous pricing conditions for short supplier payment terms, and therefore short delivery deadlines.
Optimize inventories and the company's production chain
Dormant stock represents a risk of reducing the company's available cash flow. Dormant stock generates no wealth or added value for your organization. Certain products are likely to become unusable if stock rotation is insufficient.
Obsolete or out-of-date stock has a negative impact on your sales margin and your company's operational performance.
To optimize your inventory, you can deploy several strategies:
- Reduce your delivery times.
- Manage order quantities as precisely as possible and control stock-outs.
- Improve production line processes and replenishment requirements.
Adjusting your inventory and production levels frees up cash. You don't needlessly tie up part of your funds to build up stock that's at risk of expiry or obsolescence. This is the just-in-time strategy.
What are the solutions for financing working capital requirements?
Once you've calculated your working capital requirements, you can choose from a range of solutions to finance cash flow shortfalls and guarantee your operating cycle:
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Equity capital: this comes from your profits or shareholders. They can be used to cover the need expressed by a positive WCR.
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Take out a bank loan: banks offer short-term loans to finance your cash flow needs. This type of financing allows you to anticipate future shortfalls calculated on the basis of normative WCR.
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Opt for factoring: this method involves buying back part of your trade receivables through a bank or intermediary company. The selected organization advances the amount of customer invoices before they fall due, and takes charge of collection.
Interpreting WCR is a strategic issue for optimizing an organization's cash flow. Thanks to the WCR calculation method, it is possible to refine financing requirements through the implementation of normative thresholds.
