How useful is the WCR for the financial management of a company?
What is WCR (Working Capital Requirement)?
In accounting and finance, WCR refers to the funds needed to operate a business. In practice, the organization generally needs to purchase raw materials or goods before it can sell products. The cash flow gap between the cash outflow from purchases and the cash inflow from sales must then be advanced by the company to conduct its business. This amount is called Working Capital Requirement (WCR).
WCR corresponds to the cash that the company must have at its disposal to cover its current costs.
What role does WCR play in the finance function?
The finance function uses the WCR to determine the company's short-term financing needs. This key indicator helps to establish the company's cash flow forecast and to monitor its costs over time. If there is a cash flow deficit when compared to forecasts, new sources of financing must be found to support the company's business.
With continuous WCR monitoring, it is also possible to detect potential difficulties that the organization may be facing. It is an important indicator that determines the financial health of the company and its ability to sustain itself.
Which KPIs should you look at to best analyze your WCR?
The working capital requirement depends on 3 elements:
- the company's current inventory;
- its customer receivables, i.e. invoices not paid at the time the balance sheet is drawn up;
- its accounts payable as well as its tax and social security debts.
The formula for calculating WCR is as follows:
The company's WCR can be calculated from the annual accounting balance sheet (or the projected balance sheet when a company is launched).
Why and how can you reduce your WCR?
Depending on the case, the result of the WCR can be negative, zero or positive.
WCR calculation: how do you analyze the result?
A negative WCR means that the company's revenue is greater than its disbursements at a given time. The margin generated by the business feeds into the company's cash flow positively. This is often the case in the retail sector where customer receivables are paid at the time of purchase, while supplier invoices can be paid within 60 days.
When current assets and liabilities are balanced, the WCR is zero: the company does not therefore need financing. But in the majority of cases, the WCR of a company is positive. The company must then have sufficient working capital to finance its ongoing costs.
In some industries, WCR can be particularly high without this necessarily being a sign that the business is in a poor state.
This is particularly the case in:
- start-ups in which the business activity is not yet sufficient to cover their high development needs;
- industrial companies where the operating cycle can be long, with inventories that are sometimes large and customer payment terms that are quite long;
- some service-industry companies that have to incur significant costs before they can bill for their fees;
- real estate companies where payments can be slow to arrive.
To finance their working capital requirement, these companies will have to resort to a financing solution tailored to their needs, such as bank credit, raising equity or Revenue-Based Financing which is specially designed for e-tailers, SaaS companies, and innovative businesses, using their future revenue forecasts to provide them with a cash advance in only 24 hours.
How do you reduce your WCR?
The higher the WCR, the more cash the company will need to finance its activities. In case of unforeseen events, there may be a risk of financial difficulties. For the finance function, the objective is therefore to reduce the company's WCR as much as possible.
To optimize the company's WCR, the finance function can:
- improve its inventory management. This can be done byacceleratingstock rotation, reducing the number of items ordered or reducing the number of items to limit the impact on cash flow: the more stocks are reduced and sold out quickly, the better your cash flow will be. However, you should be wary of the risk of running out of stock.
- Shorten the time it takes to pay customers. The number of days between delivery to the customer and collection should be minimized. Industry practices and economic conditions must be taken into account.
- Extend payment terms to suppliers. Depending on the flexibility and habits of the sector, it is sometimes possible to play about with the payment period of supplier invoices to keep up cash flow. But you should be aware that this may have an additional cost.
For example, by financing via RBF, you free up cash flow to pay your suppliers in cash, among other things. And so:
- Cash flow is eased through cost reduction negotiations that work for all parties;
- The payment terms are reduced, and often delivery deadlines too.
WCR: how can the finance function quickly fix its working capital requirement?
WCR: a financial indicator to be scrutinized over the long term
On an as-and-when basis, the WCR can indicate to the company's financiers how much money the company should have available each month to cover its current costs and build an annual cash flow plan. Beyond that, long-term monitoring of WCR can be used to detect any financial difficulties.
An increase in WCR should alert you and encourage you to act on one of the three levers of action (inventory management, customer receivables and accounts payable). On the other hand, a decrease in WCR indicates to decision-makers that it is appropriate toinvestto increase the company's profitability. In the event of WCR stability, the possibility of optimizing your cash management can be considered to improve the solvency of your company.
How can you best fix your WCR over the long term?
To act on one of the 3 levers of WCR, the time needed can be significant. You will have to identify the customers and suppliers most likely to accept changes in payment terms, or implement a new inventory management policy.
To act quickly with regard to your WCR, you can also try to optimize your cash flow management. With the help of software like Agicap, it is possible to simply obtain a better visibility of your costs and revenue in order to optimize your payment operations and collection of accounts receivable.
This may involve paying your suppliers on time, or reminding your customers before the invoice payment deadline to encourage them to pay more quickly. With a rigorous monitoring of your cash flow, it is easier to optimize your operations and tidy up said cash flow.
In short, while working capital requirement is primarily a short-term financial indicator, its variations can be used by the finance function to optimize its cash management and strengthen its profitability. This makes it a key piece of data for financial experts and managers, as well as for partners and investors.
