Working Capital Requirement (WCR) is a crucial key performance indicator (KPI) for maintaining the financial health of your business. Understanding and optimizing your WCR can help manage cash flow efficiently, make informed strategic decisions, and drive business growth.
What is Working Capital Requirement (WCR)?
WCR is the amount of liquidity a company must have to cover its expenses during the period before receiving payments from its customers. It's a sum that the company must constantly have to finance the cash flow gap between incoming and outgoing funds. This gap is normal in the course of business operations but must be resolved in the short term.
For example, this gap occurs when a company pays its suppliers within one month while its own customers have 60 days to pay their invoices. The company must settle this debt within the specified period upon receiving payment from its client.
Generally, companies have a WCR greater than 0 (positive), meaning they need to find financial resources to support these cash flow gaps. This is particularly true for online stores that must prepay suppliers while waiting for purchases to be made on their platform. These companies offer a service, acting as intermediaries between buyers and sellers without holding stock. They still need to advance the amount of current expenses to invoice their services, creating a liability on their balance sheet.
It's important to note that this cash flow gap can also be surplus: some business activities involve companies receiving their invoiced amounts before paying their suppliers. In this case, they are referred to as having working capital resources, not needing funds to finance their working capital as they use their own circulating funds.
Key Components of WCR
WCR is generally calculated using the formula:
WCR = Inventory + Accounts Receivable - Accounts Payable
Three main factors influence this calculation:
- Supplier Payment Terms: Calculated by dividing the amount of accounts payable by the total purchases (including VAT) and multiplying the result by 360. The payment term, measured in days, corresponds to the latency granted by the company's suppliers, typically ranging from 30 to 60 days.
- Customer Payment Terms: Calculated by multiplying by 360 the sum obtained by dividing accounts receivable by the total revenue (including VAT). This KPI varies from one activity to another.
- Inventory Turnover Days: Calculated by dividing the average inventory value by the production cost and multiplying by 360. This KPI defines the number of days the product is in stock.
For an e-commerce company that invoices a service under the term "work in progress," WCR is determined by considering several factors: the cost of one day of activity, current expenses (energy costs, employee salaries), and the number of latency days between the customer order and the completion of the mission.
Why is WCR Important?
Understanding your WCR has several advantages. It supports the company's operating cycle and is crucial for establishing a realistic business plan. Many companies prefer to estimate their working capital needs before the actual creation of their structure. Poor estimation of WCR can cause the premature end of a business unable to support its current financial obligations with its own cash flow.
A positive WCR indicates short-term financial autonomy and good health: the company can support its current expenses without needing to receive customer payments first. Therefore, working capital is considered a key indicator of a company's viability.
It helps to draw up a realistic and accurate balance sheet that considers the operational variations of the structure. Analyzing the results obtained during the definition of WCR allows identifying strategic development areas or redirecting company operations.
How to Optimize Your WCR
To improve your WCR, it is recommended to regularly analyze your results. Businesses should calculate and compare their WCR results weekly or monthly. Notable changes from one period to another, if explained, can help make informed decisions to develop the company's financial situation.
Good WCR management requires the use of accounting and analytical tools to improve cash flow and optimize inventory. It involves up-to-date accounting, efficient stock management, and strong relationships with clients and suppliers.
It's also essential to understand financing methods: Dailly assignment, invoice factoring, cash flow credit, bank overdraft, etc. Understanding and using these different financing methods can be beneficial for optimizing your WCR.
Financing Solutions for a Negative WCR
If your WCR is negative, several options are available. You can use your working capital, which acts as a safety margin to cover the failure of one or more clients. This involves capital that is continuously available in the company to ensure its operation cycle or receivables in the form of payments that will be received after a certain period.
You can also request cash flow credits from your bank to obtain a short-term overdraft authorization. These loans allow for a short-term overdraft to cover delays in incoming cash.
Silvr: Your Partner for Optimizing WCR
At Silvr, we understand the importance of WCR for your business's financial health. Our short-term financing approach offers an alternative to traditional methods, particularly suited for growing SMEs. We provide flexible financing solutions that can help you manage your WCR efficiently, using advanced data analysis technology to quickly assess your growth potential.
