Everything about cashflow & working capital requirements

Working capital requirements (WCR) is a financial indicator that can sometimes be difficult to understand. Yet calculating a company’s WCR is relatively simple – and knowing what it is can be very useful. Closely linked to cash in hand, being aware your WCR enables you to plan for the company’s financial health and hence take action where necessary. This can be a major challenge, both when difficulties of any kind arise, but also when you’re trying to develop the business. Working capital requirements and cashflow: taking stock of these fundamental concepts, so that you can understand them.

Working capital requirements: definition, calculation and challenges

The WCR is the amount of money that the company has to finance to pay for its overheads while waiting for its outstanding customer invoices to be paid. In basic terms, it is the difference between receipts and disbursements – or money in and money out.

Illustration: if the company pays its suppliers at 30 days, while its customers only pay the company at 60 days, the company has a positive WCR. Which means it needs to have sufficient cash to be able to pay its ongoing overheads while awaiting settlement of the money owed to it.

Positive or negative WCR

The formula for calculating working capital requirements is as follows:

WCR = stock + receivables – debts

How is the result interpreted?

• Positive WCR: this means that the company has to finance the difference between its receipts and its disbursements. This is often the case when the company allows its customers more time to pay than the payment terms it has negotiated with suppliers. Cash is the most common way to finance positive WCR.
• Negative WCR: this means that money by the company is received before it is paid out to suppliers – frequently seen in the mass retail sector. Negative WCR then becomes a financial resource for the company.

The link between working capital and working capital requirements

Working capital is the money actually available in the company’s coffers to finance its business. It is worth comparing working capital and working capital requirements:

• If the WCR is higher than the working capital, the company requires money in excess of its resources and so needs to find a way to finance itself to pay for its ongoing overheads – suppliers, salaries, property, tax, etc.
• If the WCR is lower than the working capital, the company’s cashflow is at least sufficient to pay for its overheads. This means that the company does not need to resort to borrowing in order to finance its operations, because its cash reserves allow it to do so.

So it is cash that makes the link between operating capital and WCR.

Cash: definition and challenges

Cash refers to the equity held by the company. These funds represent a precious cash resource, not only enabling the company to pay for its overheads, but also to invest in new projects with high growth potential. Beyond this very tangible financial aspect, cash has a psychological impact on the person running the company – and on the teams working in the company. A low level of cashflow generates stress and uncertainty…

When the working capital is higher than the WCR, the company manager can relax: the level of cashflow is positive and the company can pay its overheads and develop its business. On the flipside, if working capital is lower than the WCR, this is a source of concern: it means that the company’s cashflow is in the red and solutions have to be found to avoid the company being unable to pay its debts – and those solutions are often costly.

What are the triggers for increasing working capital and reducing WCR?

By increasing its working capital and/or reducing its working capital requirements, the company is able to maintain sufficient cashflow. This means that overheads are paid on time, the outlook for growth is good and the company manager can run the business with peace of mind.

How do you increase working capital? 

This is done by bringing money into the company’s coffers. There are a number of strategies to adopt here:

• Increase equity capital: allocate profits to the reserves, implement an increase in capital, take out a long-term loan, etc.
• Dispose of fixed assets – non-essential property or investments.

What ways are there to reduce working capital requirements?

• Optimize customer accounts receivable: shorten customer payment terms, ask for deposits, send out systematic reminders to late-payers, etc. These are all actions that enable the WCR to be reduced without too much effort.
• Negotiate longer payment terms with suppliers so that money can be collected from customers before having to pay suppliers.
• For tax and social debts, opt to pay quarterly rather than monthly.
• Cut back on stock levels to avoid dormant stock – which increases working capital requirements.

Customer accounts receivable is the most effective area where you can reduce your WCR. You can achieve fast results by using good software for recovering receivables: automated reminders enable you to collect your debts more quickly, without having to deploy additional human resources.