Calculating WCR: everything you need to know about working capital requirements

What is WCR?

WCR is a strategic accounting indicator in company management.

A definition of WCR (working capital requirement)

WCR, working capital requirement, corresponds to the cash a company needs to finance its day-to-day activities. It excludes recourse to external financing. WCR can be summarized as the difference between :

• current assets: inventories, customer receivables, etc;
• and current liabilities: accrued expenses, trade payables, etc.

WCR represents the amount a company needs to finance in order to cover requirements resulting from timing differences between cash flows: expenditure and income.

A company's operating cycle

A company's operating cycle can be defined in several stages:

1. Raw materials procurement: the company purchases raw materials to produce goods or provide services.
2. Production: the company designs finished products or provides services.
3. Finished goods storage: finished goods are stored with a view to being sold.
4. Sale of finished products: finished products are sold to customers.
5. Customer receivables: payment terms are granted to customers.

Thus, WCR represents the time lag between the purchase of raw materials and the payment by customers of receivables for the products or services they have used.

The fundamental principle of WCR

WCR is based on a fundamental principle:

• a claim is not settled immediately by the customer ;
• stock is not sold immediately.

These two time lags generate a financial requirement for the company. To finance this, the company can negotiate payment terms with suppliers using working capital or cash flow.

Why is it essential to know a company's WCR?

A company cannot function without available cash. It enables the company to cover its operating expenses on time. Cash is essential for acquiring the raw materials needed to design products. Knowing your WCR is the key to optimal day-to-day management of your business.

A manager in control of his WCR has the levers to balance incoming and outgoing cash flows. Calculating WCR helps minimize the risk of a cash shortfall. This balance guarantees the company's long-term viability in an uncertain economic climate.

WCR is a reliable indicator for defining or adjusting inventory management strategy. It can also be used to fine-tune the management of trade receivables and payables. These three elements have a direct impact on a company's cash flow. Knowing your WCR gives you the means to optimize your cash flow and guarantee your long-term financial health.

How do you calculate WCR?

The formula for calculating WCR is simple:

• WCR = trade receivables + inventories - trade payables

Positive and negative WCR: what are they?

To interpret working capital requirements, it is important to understand the differences between positive and negative WCR.

Positive WCR: a definition

Positive WCR is the financial indicator showing that the company needs to finance its current operations before receiving payment from customers.

What is positive WCR?

This is a situation in which the company's assets exceed its liabilities. The positive WCR reflects massive investment in short-term assets. Conversely, the company has few short-term credits with its suppliers.

Solutions for correcting positive WCR

A company with a positive WCR must look for solutions to meet its financing needs before customer payments are received. It can choose one of the following two solutions:

• Increase capital by injecting additional funds from the company's shareholders.
• Use bank loans to maintain sufficient liquidity.

Why correct a positive WCR?

A company can deliberately opt for a positive WCR. One strategy is to stockpile heavily in anticipation of strong demand. If the situation is not deliberately strategic, it is important to seek to correct the positive WCR.

A positive WCR can lead to problems of insolvency or dependence on external financing. To prevent this problem, managers should keep a regular watch on operating cycles: supplier debts, customer receivables, inventories, etc. Vigilance helps maintain balance in a company's finances. It limits the risk of financial mismatches.

Negative WCR: a definition

Negative WCR has a number of advantages for a company, particularly in terms of its financial operations.

What is negative WCR?

Negative WCR indicates that the company has internal sources of financing from its operating cycle. It is generated when current liabilities exceed current assets. The company receives payment from its customers before it pays its suppliers.

A positive indicator for the company

In a positive WCR situation, a company operates on funds provided by its suppliers. This reduces the company's need for external financing to carry out its day-to-day operations. The extended payment terms offered by suppliers, combined with immediate payments from customers, lead to a cash surplus. As a result, the company enjoys greater financial flexibility.

Negative WCR: an effective business strategy

A negative WCR is the symbol of efficient management of a company's operating cycle by its managers. Longer payment terms should be negotiated with suppliers in advance.

Good to know: An asset corresponds to a company's total assets: buildings, equipment, receivables, patents, etc. Fixed assets (goodwill, equipment, etc.) must be separated from current assets (trade receivables, inventory, bank credit balances, etc.).

Liabilities represent a company's resources, enabling it to finance its assets. They are made up of shareholders' equity (fixed liabilities) and debts (current liabilities).

Zero WCR: what is it?

A zero WCR represents a situation of balance between uses and resources. The cash flows required to operate a company are balanced. When working capital is zero, no surplus can be invested. The company's net cash position is zero. Every day, revenues cover the company's expenses. Net cash flow is calculated using the following formula:

• Net cash = Working capital - Working capital requirement

What is normative WCR?

To manage and optimize its working capital requirements, a company needs to control its cash flow.

Differences between working capital requirements and normalized WCR

Operating working capital (OCC ) is an important factor in a company's financial management. It is a key financial indicator. It measures a company's cash requirements over a given period. It takes into account the actual time lag between collection of trade receivables, inventory turnover and payment of trade payables.

Normative working capital quantifies all the requirements a company needs to finance its future operating cycles. Normative WCR has a forecasting function. In contrast, WCR is calculated retrospectively, on the basis of balance sheet items: trade receivables, trade payables, tax and social security liabilities, and inventories.

Calculating normative WCR

Normative WCR is calculated on the basis of the average figures for the items making up working capital. First and foremost, therefore, we need to determine the normative level for each of the operating working capital items.

The WCR formula is repeated with normative data to give normative WCR :

• Normative WCR = normative inventories + normative operating receivables - normative operating payables

Interpreting the normative WCR result

The normative WCR is a complement to the BFRE. It provides a complementary strategic analysis. It offers a solution for controlling items that have an impact on working capital requirements. It enables you to make highly accurate financial forecasts.

The advantage of the normative WCR is that it provides an assessment of future operating requirements based on sales forecasts. It provides a sound basis for managing a company's growth, taking into account potential cash requirements, which are essential for financing the operating cycle.

The normative WCR identifies the main components linked to a company's activity and organization. Its determination offers a solution for designing action plans to be applied to items requiring strategic attention.

Based on the normative WCR calculation, a company's management can decide on a strategic course of action. This may mean, for example, speeding up the collection of trade receivables. Other managers may choose to streamline the procurement process to reduce inventories.

Normative WCR: a forecasting function

Unlike the BFRE, which operates retroactively, the normative BFR has a forecasting function. It is expressed in days of sales. This indicator focuses on company data. When the forecast obtained is not optimal, managers draw up action plans.

What are the differences between WCR and WCF?

In order to understand working capital requirements, we need to separate them from working capital (WC) itself.

What is working capital (WC)?

Working capital is an equally essential financial indicator for managing a company. It measures the surplus or deficit of long-term resources in relation to the company's fixed assets. Working capital is calculated using two methods:

• based on the difference between permanent capital and real estate assets ;
• after subtracting current liabilities from current assets.

A company can have positive, zero or negative working capital. The state of the WCF reflects the financial health of an organization.

Positive working capital

The positive FR indicates that the company has long-term resources to finance its fixed assets. It indicates that the company is in good financial health.

Negative working capital

The negative FR describes a worrying situation for a company. The company does not have sufficient long-term resources to cover its fixed assets. The company's financial risk therefore requires particular attention.

Zero working capital

The zero FR indicates that the company's long-term resources are equal to its fixed assets. The company has no financing surplus or deficit.

A good analysis of working capital enables you to monitor a company's financial equilibrium. It provides an overview of the balance between resources and uses.

WCR or FR: the practical differences

Although WCR and FR are two related financial indicators, they play completely different roles in a company's financial management:

• WCR is the essential amount needed to finance a company's operating cycle. It is the difference between cash disbursements and cash receipts. It provides information about the company's short-term financing needs.
• The FR measures the long-term resources available to a company. These resources are available because they have not been used to finance fixed assets. It is a financial reserve which can be used to cover operating expenses.

WCR focuses on financing the company's operations. Working capital, on the other hand, finances fixed assets.

Good to know: Real-estate assets include securities, bills of exchange, shares and accounts. A property can be considered a real estate asset when it is part of a company's assets at the time its balance sheet is drawn up.

How to reduce a company's working capital requirements?

Controlling working capital enables you to analyze cash shortfalls at source. It enables you to activate levers to optimize your working capital requirements.

Optimize customer assets on the balance sheet

Outstanding accounts receivable is one of the key items for optimizing a company's WCR. With this in mind, several strategies can be adopted:

1. Reduce payment times : rapid receipt of customer payments helps to boost cash flow. WCR moves into negative territory.
2. Ask for a deposit on order : a way of capturing part of the payment due, without putting the customer in difficulty, while steering your WCR into negative territory.
3. Monitor payments, then follow up with customers: negotiating deadlines means respecting them. It's essential to follow up with customers as soon as an unpaid invoice falls due.
4. Provide for late payment penalties and discounts: to encourage customers to pay on time, it's strategic to provide for late payment penalties. In the event of difficulties experienced by your customers, it's a good idea to schedule discounts to reduce the risk of non-payment to 100%.
5. Improve invoicing: an invoice issued quickly leads to favorable payment terms, reducing risks and settlement times.

Optimize your supplier base

Another strategic concept is to maximize your suppliers' payment terms. It is important, however, to comply with legislation.

1. Increase payment terms as much as possible: this involves obtaining longer payment terms for supplier invoices. It is important to respect payment deadlines to avoid late payment penalties.
2. Negotiate advantageous financial conditions to obtain short supplier payment terms.

Optimize inventory

Inventories include raw materials, merchandise and packaging required by a company or entrepreneur. Several actions can be taken:

• Optimize production flow and the supply chain.
• Don't produce more than you need to in relation to customer sales.
• Increase destocking of slow-moving products.

Working capital is a key strategic indicator for determining a company's financial health. It is used in the creation process of an organization through the business plan. It should be calculated throughout the life of the company to fine-tune its development strategy.