How To Calculate Working Capital Requirement Of A Company?
To maintain profitability, a business owner must harness efficient working capital management strategy.
Without sufficient working capital, a firm will not only incur losses but also find it challenging to
continue its operations without interruptions. In this article, you will learn how to calculate working
capital requirement, and determine working capital needs for business.
The best way to ascertain that is by understanding your firm’s working capital requirements.
What is Working Capital Requirement?
Working Capital Requirement (WCR) is the monetary sum necessary to meet your operational expenses,
reflecting your company's immediate financial needs. It displays the short-term finance needs of your
business. These needs are brought on by inconsistencies in your cash flows (the money that comes in and
goes out), which correlate to the cash inflow and cash outflow related to your business operations, or
more precisely, your company's main activity. The working capital requirement formula calculates the funds
necessary to meet a company's day-to-day operations and short-term financial obligations by taking the
difference between current assets and current liabilities.
In simple words, working capital requirement can be described as the amount of money a
firm would need to bridge the gap between its accounts payable and accounts receivable. It is essentially
the amount a business requires to keep its operations afloat.
In the case of working capital deficit, businesses can use their outstanding invoices and avail funds to
meet their working capital requirement. With KredX businesses can utilise their unpaid invoices to avail
working capital within 24 -72 hours*.
Three Reasons Why Working Capital Requirement Gaps Appear
The three main reasons why Working Capital Requirement (WCR) gaps can appear are:
1. Seasonal Fluctuations
Some businesses experience seasonal variations in sales and cash flow. During peak seasons, they may need
additional working capital to manage increased inventory levels, hire temporary staff, and meet higher
customer demands. Conversely, in low seasons, they might face a surplus of inventory and lower sales,
leading to a temporary surplus of working capital.
2. Rapid Business Growth
When a company experiences rapid expansion and growth, it often requires more working capital to finance
increased production, purchase additional inventory, hire more employees, and extend credit to customers.
If the growth is not matched with sufficient financing, it can lead to a working capital shortfall.
3. Delayed Payments and Slow Receivables
If a business faces delays in receiving payments from customers or has a significant portion of its
accounts receivables outstanding for an extended period, it can strain the available working capital. The
company may struggle to pay its own suppliers and meet immediate obligations, resulting in a working
These factors can create fluctuations in the working capital requirements of a company and highlight the
importance of effectively managing working capital to ensure the smooth functioning of the business and
avoid potential liquidity problems.
Factors That Help To Determine Required Working
These are among the top factors that help businesses determine their working capital requirements
A significantly high sales volume generates high revenue which means the working capital required
is not much.
Duration of Operating Cycle
The longer it takes a business to convert current assets into cash and cash equivalents, the more
will be the required working capital.
Type of Business
Trading businesses require relatively high working capital when compared to manufacturing
Terms of credit
Businesses that extend longer terms of credit to customers are often in need of more working capital.
Stagnant or slow turnover of extensive inventories results in a higher working capital
Businesses that are dependent on specific seasons may need more working capital.
Usually, labour-intensive businesses require more capital than a business which needs the use of
A provision to meet the changes in demand and products’ price.
Components of Working Capital
All components of working capital are found on a company's balance sheet, though not all elements may be
applicable to every business. For instance, a service company without inventory will exclude inventory
from its working capital calculation.
Current assets encompass economic benefits expected within the next 12 months, including:
- Cash and Cash Equivalents: All available money, including low-risk investments like money market
- Inventory: Unsold goods, including raw materials and finished products.
- Accounts Receivable: Claims to cash for items sold on credit.
- Notes Receivable: Claims to cash from other agreements, usually formalized by a signed contract.
- Prepaid Expenses: Value for expenses paid in advance, though not easily convertible to cash.
- Others: Any additional short-term assets, such as short-term deferred tax assets.
Current liabilities represent debts a company owes or will owe within the next twelve months:
- Accounts Payable
Unpaid invoices to vendors and suppliers for various operating expenses.
- Wages Payable
Unpaid accrued salary and wages for employees.
- Current Portion of Long-Term Debt
Short-term payments related to long-term debts scheduled within the next 12 months.
- Accrued Tax Payable
Accruals for tax obligations due within the next 12 months.
- Dividend Payable
Authorized payments to shareholders, even if future dividends are declined.
- Unearned Revenue
Capital received in advance for work yet to be completed.
The main objective of assessing working capital is to determine if a company can meet its short-term
liabilities with the existing short-term assets on hand. Businesses analyze these components to gauge
their financial position and ensure effective management of working capital for a stable and thriving
How To Compute A Company's Working Capital Requirement?
The working capital requirement formula calculates the difference between a company's current assets and
current liabilities, providing insights into its short-term financial needs. The formula for calculating working capital requirement is
given by -
Working Capital formula = Current Assets - Current Liabilities
Here, current assets include these following -
- Cash in hand
- Cash equivalent
- Company inventory
- Accounts receivable
- Pre-paid liabilities
Here, current liabilities include these following -
- Accounts payable
- Notes payable
- Income tax owed
- Immediate debts
Based on this working capital requirement formula, businesses can estimate their working capital
For instance, if the current assets of a firm exceed its current liabilities, it indicates that the firm
has surplus working capital. Notably, items like cash commitments, non-trade receivable and old or wasted
inventory are excluded or adjusted during the working capital requirement calculation.
How to Calculate Working Capital Requirement | Example of Working Capital Requirement Calculation
Suppose the current assets of Mr Kumar’s business stands at Rs. 25000, while current liabilities
amount to Rs. 45000.
Using the formula -
Working capital = Current assets - Current liabilities
= Rs. (25000 - 45000)
= - (Rs. 20000)
Since the outcome is negative, it indicates Mr Kumar’s business has a deficit in working capital.
It means that his firm’s immediate liquidity is not enough to optimise everyday functions.
Some of the effective ways of reducing working capital gap include -
- Quick collection of accounts receivables
- Reducing inventory cycle
- Reducing credit terms
- Increasing sales volume
How to Find Working Capital?
However, to meet your working capital requirement immediately and to keep operational
activities continuous, you can opt for alternative solutions like invoice discounting services from
Limitations of Working Capital
Working capital analysis is a valuable tool for assessing a company's short-term financial health.
However, it also comes with certain limitations and considerations:
Exclusion of Long-Term Perspective
Working capital requirement ignores the long-term financial picture in favor of concentrating only on
short-term assets and liabilities. It does not give a complete view of a business's total financial
situation or its potential for long-term growth and profitability.
Different industries have varying working capital requirements. Comparing working capital ratios across
industries may not provide meaningful insights, as each industry operates under unique business models and
cash flow dynamics.
Businesses with seasonal sales patterns may experience temporary fluctuations in working capital
requirements. This can lead to misleading interpretations if working capital is assessed during a specific
seasonal peak or trough.
Inadequate for Capital-Intensive Businesses
Companies with significant capital investments, such as manufacturing firms or infrastructure projects,
may have higher fixed asset requirements. Working capital alone may not adequately reflect their financial
Does Not Consider Non-Cash Items
working capital calculation emphasize cash as well as current assets and obligations. Depreciation,
amortization, and other non-cash costs or profits that affect a company's cash flow are not taken into
Inflation and Currency Changes
Working capital ratios may be affected by inflation and currency fluctuations, which can distort the
value of current assets and liabilities over time.
Working capital needs can be influenced by management decisions, such as delaying payments to suppliers
or accelerating collections from customers. In some cases, companies may manipulate working capital
calculation to present a more favorable financial position.
Limited for Comparative Analysis
While working capital ratios can be compared over time for a single company, comparing them across
different companies may not be meaningful due to variations in accounting policies and financial reporting
No Consideration of Quality of Assets
Working capital needs analysis does not account for the quality or liquidity of current assets. For
instance, a high level of inventory may indicate slow-moving or obsolete items, affecting the company's
In spite of these drawbacks, working capital is nevertheless a useful statistic for short-term financial
management since it can give important information about a company's liquidity, operational effectiveness,
and capacity to pay short-term obligations. To do a thorough analysis, it is essential to combine working
capital needs analysis with other financial measures and take into account the company's overall financial
Ensuring future business growth necessitates the accurate determination of working capital
Government stimulus programmes and tax breaks during the past year have helped the economy by injecting
much-needed liquidity and supporting enterprises. The opportunity to obtain working capital
loans with advantageous conditions has enabled businesses to benefit from the current climate of
cheap interest rates, enabling improvements, project expenditures, and strategic acquisitions that pave
the way for future success.
However, before proceeding with investments, it is prudent to seek expert trade and risk analysis to
strike a balance between being overly aggressive due to the fear of missing out (FOMO) and being overly
cautious, which may risk falling behind competitors. It's essential to recognize that the recovery may
vary from country to country, impacting the choice of investment targets. Engaging an expert trade credit
insurer can offer valuable advice, empowering you to make well-informed decisions.
Determining your working capital requirements and staying attuned to any changes provides a safety net
for your company, enabling flexibility and fostering a forward-looking approach for future growth. By
understanding these dynamics and planning strategically, businesses can navigate uncertainties and seize
opportunities to thrive in the long run.
Analyzing Working Capital Requirement
By contrasting current assets and current liabilities, you can learn more about your company's financial
status while analyzing the working capital demand. There are three possible possibilities to take into
- If your working capital requirement (WCR) is positive, your company needs to secure funding to meet
short-term obligations. Vigilance and proactive measures to seek financing may be necessary. Various
ways to finance the WCR will be explored later in this article. For additional insights, you may also
want to read about anticipating and managing cash flow when dealing with elevated WCR.
- If your WCR is zero, your company has sufficient operational resources to cover all its requirements
without the need for additional financing. In this situation, there is no surplus or deficit in working
capital. It's worth noting that having a WCR of exactly zero is rare in reality.
- If your WCR is negative, your company doesn't have immediate short-term financial needs, allowing you
to allocate resources towards funding net cash flow. This surplus in working capital can potentially be
used to invest in growth opportunities or other strategic initiatives.
Working capital requirements play a vital role in shaping a company's financial landscape. Efficient
management of working capital ensures a smooth and resilient operation, allowing businesses to meet their
short-term financial obligations and seize growth opportunities. Maintaining positive working capital is a
sign of stability, while addressing negative working capital is essential to avoid liquidity challenges.
By continually monitoring and optimizing working capital, businesses can thrive in a competitive
environment and achieve long-term financial success.
A. A firm can find out whether it has sufficient working capital or not with the help of
current ratio. Typically, a ratio of 2 is considered ideal for a firm. However, such a ratio
may vary from one industry or business to another
A. Minimum working capital can be defined as the least amount of capital required to keep a
business operating without the need to avail a business loan or other funding options to
A. Every firm, irrespective of their size must practise active working capital management as
it helps them to keep their operations running smoothly. It further improves earnings and
A. There are 3 methods of forecasting or estimating the future working capital of a firm.
They are - the percentage of sales methods, operating cycle method and regression analysis