Control your WCR and optimise your financial autonomy
Working capital, commonly referred to as WCR, is a cash flow indicator that is essential for a company to understand and control.
Working capital requirement: definition
The WCR enables the company to know how much money it needs to cover the cash flow differences between cash outflows and collections. If miscalculated and misinterpreted, it could affect the financial health of the company.
To better understand the importance of working capital, we need only look at concrete examples.
When a company sells a service or a good, it will agree a payment term with its customer, the investment will not be paid immediately.
Similarly, when it needs to replenish its stocks, it will make a bulk purchase. However, the stock will not sell out immediately and will therefore not bring in any immediate income.
While waiting for its investments, a company will still have to pay its debts and its employees. This can lead to shortfalls in its treasury and thus to short-term financial needs. Either the company has the necessary funds in its treasury or it will need working capital. In any case, it is strongly advised to anticipate and calculate this potential gap in your treasury budget.
The WCR provides an insight into the financial autonomy of a company. This is one of the few indicators that is best kept negative.
Indeed, if it is equal to 0 or negative, it means that the company is able to cover its short-term debts, i.e. to fully finance its next operating and employment cycle. Moreover, when the WCR is less than 0, we no longer speak of working capital requirements, but of working capital resources.
If, on the other hand, it is positive and you have no surplus treasury to cover it, you will have to think about how to finance it.
Why and how to calculate your WCR?
Calculating your working capital requirements, as you will have understood, enables you to know how your treasury is doing. This can be easily calculated using the Balance Sheet. On the latter, the WCR is the difference between current assets and current liabilities:
- WCR = current assets – current liabilities
You can do the calculation yourself using the following formula:
- WCR = (amount of stocks in progress + amount of receivables in progress) – liabilities
How to better manage your WCR?
WCR can vary according to different elements. The main elements will be the period of investment granted to customers and the payment period set by suppliers. It is better to get paid before you pay to reduce your working capital requirements. Also consider optimising your customer direct debit methods.
The length of the company’s operating cycle may also have an influence. The longer it takes, the higher the WCR is likely to be.
Finally, the quantity and level of stock rotation should also be taken into account. Dormant stocks are best avoided as they increase working capital requirements as long as they remain unsold.
How to finance your working capital requirement?
If, however, your working capital requirement turns out to be greater than 0, your business will need to find a means of financing. Different solutions are possible for financing working capital:
- Negotiate an authorised bank overdraft if your WCR is low
- Provide equity if you are able to do so
- Apply to your bank for a loan
- Use debt collection methods such as assignment dailly or factoring
- Search for investors to obtain financing
Obviously, you will need to assess which is the best option taking into account the amount of your WCR and especially whether your financial needs are likely to be short, medium or long term.