Working capital requirement or WCR is the money required for a business’s smooth operations. Working capital requirement calculation is crucial to determine a company’s supply chain finance needs. Let’s understand its meaning, formula, and calculation method.
Every business owner must stay prepared for two things during their business cycle – market volatility and the ever-growing working capital requirement. While not entrepreneurs have deep pockets to aid their needs, many look forward to SME loans to cover the costs of business expansion, equipment purchase, and hiring staff. Supply chain finance provides equal opportunities to all business owners to improve their operations without stressing their finances. However, before applying for a Business Loan, it is crucial to understand what WCR is, its significance, and how to calculate it.
Why is Working Capital Essential?
Working capital works as a lubricant to keep your business running smoothly. You must use it to fund your operations and fulfil short-term obligations, such as paying salaries to employees, clearing supplier bills, restocking inventory, etc., even during cash flow challenges. Apart from handling your working capital needs, you may also use it to fund business growth. Even if you have to borrow a Business Loan for that purpose, positive working capital would be an essential eligibility requirement. Working capital is necessary to estimate the cash on hand, maintain sufficient cash flow while covering liabilities, and have some leeway for emergencies and expansion.
What is the Working Capital Requirement (WCR)?
Working Capital Requirement or WCR is a significant financial metric that shows the amount of finance necessary to cover various costs in the production cycle, debt repayments, and upcoming operational needs. Simply put, it indicates the amount of cash required to finance the gap between accounts payable and accounts receivable. A low working capital indicates liquidity issues, while an unnecessarily high working capital signifies that you are not making full use of your assets to maximise the revenues. Therefore, calculating and determining your WCR will help you find a perfect balance.
Working Capital Requirement Calculation
The working capital requirement calculation requires two major components:
- Current Assets, including physical cash in hand, assets like machinery, land, or stocks, future expenses paid in advance, etc.
- Current Liabilities, including unpaid loans and expenses, etc.
Below is the working capital requirement formula for calculating the WCR:Working Capital Requirement = Current Business Assets - Current Business Liabilities
You can derive your working capital requirement by following these steps:
- Open an Excel sheet on your computer.
- List all your current liabilities, like accounts payable, in a column, and find their sum.
- List all your current assets like inventories, accounts receivable, and cash in another column, and find their sum.
- Subtract your current liabilities from current assets to find your WCR.
Let’s look at a working capital requirements example. Suppose you are planning to expand business in a neighbouring market but cannot afford the expenditures right now. For working capital requirement calculation in Excel, list all your current liabilities and assets in separate columns and find their sum. If the sum of your existing assets is Rs 50 Lakh and current liabilities are Rs 20 Lakh, subtract total liabilities from the total assets. In this case, your current working capital requirement is Rs 30 Lakh.
Also, Read: What is Working Capital Management?
What is Affecting Your Working Capital Requirement?
Three major factors affect your working capital requirement, including the following:
- Lead Times to Sell Inventory:
When you produce goods, you know liquidating the goods takes time. Therefore, the lag between spending money on production and receiving cash after selling the products affects the WCR.
Even after finalising a sale, most buyers do not make the payment promptly. They take time to settle the transaction, causing a gap in the WCR.
If you source raw materials from suppliers, you must pay them even when the production is incomplete and goods are not sold. It requires premature cash outflow that increases your WCR.
Why Should You Calculate Your Working Capital Requirement?
Calculating your WCR is a crucial step while managing a business due to these reasons:
- Most business owners need clarification on whether to hoard cash and maximise their working capital or keep it low to leverage every opportunity coming their way. As a business owner, you must find a perfect balance between the two, which they can do by calculating their WCR.
- No matter how well you have organised your company, it might only succeed if you meet your everyday working capital needs. That is why calculating the working capital requirement is necessary.
- WCR is a crucial financial indicator of your company’s activities.
- It estimates a company’s current financing requirement, based on which you can make your borrowing decisions.
- Calculating the WCR using the working capital requirement formula helps you make informed decisions regarding your business operations, expansion plans, and cash flow management.
Also, Check: Guide to Understanding Working Capital Loans Ensuring Your Business Launches Successfully
Calculating the working capital requirement is a vital step during the initial stages of a business. In fact, inaccurate WCR calculation is a significant reason many start-ups fail. Anticipating a massive gap between the cash inflow and outflow avoids complications in the long run and keeps the business afloat. That is why calculating the WCR is essential to creating a business plan.
Conclusion
Working capital requirement is an essential indicator of a company’s financial situation. Therefore, you must calculate it regularly to follow the cash flow trends. Adjusting the supplier deadlines and managing the stock efficiently can help maintain a balance in WCR. However, when it is necessary to call on additional financing, take a Business Loan to cover your working capital needs. Use a term loan calculator to estimate your loan eligibility and opt for a repayment term with budget-friendly EMIs.
FAQs:
- What is the need for a working capital study?
Studying the working capital helps company owners evaluate their financial well-being. Accordingly, they can manage their cash flow and take borrowing decisions to sustain their operations.
- What are the working capital needs of a project?
Working capital needs depend on the nature of the project. These include supplier payments for raw materials, utility bills, employee salaries, equipment purchases, marketing plans, etc.
- What is the working capital need ratio?
The working capital ratio is the difference between a company’s current assets and liabilities. It helps measure liquidity, a business's capability to cover payment obligations.
- What are the five elements of working capital management?
Five elements of working capital management are cash, inventory, loans, accounts receivable, and accounts payable. Maintaining a balance between them is essential to operate the business efficiently.
