Working Capital Requirement

To know working capital requirement is very important for operating business without any risk. Because less or over working capital than exact working capital requirement is harmful for the progress of any business. In simple words, working capital requirement means exact amount of cash or other liquid asset to operate the business. If you have required money in the pocket of business, you need not worry for paying expenses, paying for raw material and other creditors.

Now come to the point "how to calculate working capital requirement?"

It is totally based on the nature of business. Requirement of working capital may differ in different type of business. I often compare working capital as petrol in your car. If you have to drive your car in local area, you need less petrol but if you want to travel highway for long, you need more petrol. Like this, if your business credit deal is more, then you require more capital, because one side you are buying credit and other side selling on credit. But it is not true that all debtors will convert in cash. One the other side you have to pay your full dues. So, you need big amount of working capital requirement. Minimum double of credit purchase amount. But, if you calculate average collection period and if it is less than average payment period, then you can keep less cash in your pocket.

Simple formula of working capital requirement

WCR = [Accounts Receivable + Inventory + Prepaid Expenses] - [Accounts Payable + Accruals]

You must study following points before calculating working capital requirement

1. The average time Raw materials are in stock
2. Average time to produce goods or service
3. Average time finished goods in stock
4. Credit Terms from suppliers
5. Average credit terms offered to customers
6. Estimated sales next month
7. Net Profit Margin

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