a to z of working capital in a nutshell

November 30, 2022

a to z of working capital in a nutshell

We know there are 8 types of working capitals and five of them are mainly named:

Gross working capital = Current assets

Net working capital = Current assets - Current liabilities

Fixed working capital = ??

Temporary working capital = Net working capital - Fixed or Permanent working capital.

Seasonal working capital = Fixed working capital + Additional working capital needs.

Regular working capital = ??

There are different methods to assess working capital needs like

a. % of sales method = Networking capital / Revenue *100

b. Regression method

c. Operating cycle method = Cost of Goods Sold (Estimated) * (No. of Days of Operating Cycle / 365 Days) + Bank and Cash Balance.

d. Net working capital requirement rate =

Accounts receivable = Days credit x Daily revenue
Accounts receivable = 45 x 182,500 / 365
Accounts receivable = 22,500
Accounts receivable % = 22,500 / 182,500 = 12.3% the business needs 12.3% of revenue Working capital as a result of giving credit

Then

Inventory = Days inventory x Daily cost of sales (Rev * (1-Gross margin)
Inventory = Days inventory x Daily revenue x (1 - Gross margin %)
Inventory = 30 x (182,500 / 365) x (1 - 40%)
Inventory = 9,000
Inventory % = 9,000 / 182,500 = 4.9% here the business needs WC of 4.9% of revenue as a result of taking credit.

Then

Accounts payable = Days credit x Daily cost of sales
Accounts payable = Days credit x Daily revenue x (1 - Gross margin %)
Accounts payable = 20 x (182,500 / 365) x (1 - 40%)
Accounts payable = 6,000
Accounts payable % = 6,000 / 182,500 = 3.3% here business needs WC of 3.3% of revenue as a result of taking credit.

Got it right?

Working capital requirement rate = Inventory + Receivables - Payables.

Days	Amount	% Revenue
Accounts receivable	45	22,500	12.3%
Inventory	30	9,000	4.9%
Gross working capital requirement		31,500	17.2%
Accounts payable	20	6,000	3.3%
Net working capital requirement		25,500	13.9%

Based on this information, the net working capital funding required is 13.9% of revenue. If the company gets a new project worth 100 mil $, then multiply it with 13.9% and you would need that amount of funds to fund that operation. This last method is adequate because if we substitute any of the above 3- a, b, c working capital assessment methods into the Permanent or Fixed working capital and also into Regular working capital, there is no guarantee that 'd' equates other methods to find WC requirement adequately.

100*13.9% = Net working capital - Fixed working capital (Temporary working capital) = Fixed working capital + Additional working capital (Seasonal working capital)