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Normative working capital

working capital requirement There are several approaches of the working capital requirement (WCR) and several methods to calculate it:
  • The Accounting WCR or balance sheet WCR which is based on the analysis of the balance sheet at year-end and / or intermediate. It is easy to compute but has the disadvantage to not taking into account the effect of seasonality.
It is possible that the date of exercise, so when the "snapshot" of the balance sheet is made, is not representative of the average activity of the company.

On the other hand, it does not allow a real control of working capital which is inherently volatile and depends on the level of activity of the company.

Calculation procedure Trade receivables + inventories + other receivables - trade payables - tax and social security.

The normative Working Capital Requirement

  • The normative WCR aims to overcome this drawback by performing the calculation on the basis of average figures for each component in the calculation of working capital requirements.

    Each item of WCR (receivables, inventories and payables) is evaluated in number of days:
    • Recorded average payment time of invoices,
    • Delay of inventory turnover,
    • Average payment time of supplier invoices.

    The time obtained for each item is weighted with a coefficient obtained by the cash value of the process in question back to the amount of revenue.

    For example, if the average customer payment is 65 days and the turnover for the year was € 8 million, the coefficient is 8 x 1.196 (VAT) / 8 = 1.196.

    The receivables will be contributor of 77.7 days of WCR (65 x 1.196).

    The Working Capital Requirement is valued in number of days of sales, a number that is itself made ​​up of the addition of each contributor position, knowing that payables are negative (they decrease the WCR).
This method is used to weight the main processes generating WCR and rank them in order of importance, what is relevant in the context of an action plan to reduce working capital.

Example: Company Bliss with:
  • Turnover excluding taxes (VAT) is 8 M€ and payment delay granted is 65 days,
  • Raw material purshases of 4 M€ with a storage time of 30 days and payment delay to providers is 56 days,
  • Other purchases of 1 M€ with a payment delay to suppliers of 25 days.

Calculation:

Weighting of receivables : 8 x 1,196 (VAT) / 8 = 1,196
Weighting of inventories : 4 / 8 = 0,50
Weighting of suppliers debt for raw material purshases : 4 x 1,196 / 8 = 0,6
Weighting of other purshases : 1 x 1,196 / 8 = 0,15

Process Delay Weighting WCR
Accounts receivable 65 1,196 77,7
Inventories 30 0,5 15
Suppliers debt for raw material 56 0,6 -33,6
Suppliers debt for other purshases 25 0,15 -3,75
TOTAL     55,3

The normative Working Capital Requirement represents 55,3 days of sales, which mean a value of 1212 K€ (55,3 / 365 x 8 M€).

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The Working Capital Requirement expressed as the number of days of sales is also called the WCR turnover ratio highlighting the number of days of revenue needed to finance the company's business.

It is necessary to control and anticipate changes in working capital in value and in proportion with the turnover. Monthly monitoring on both aspects of the WCR is essential to evaluate the improvement or regression of working capital management.
The advantage of the normative working capital is to assess the need for future financing of the operation based on forecasts of revenue. This is a management tool for business growth very relevant!
To go beyond the mere observation of the value of working capital, it must be analyzed and dissected in detail to determine its main components, which depend on the activity and organization of the company. This study is necessary to prioritize action plans on the most important process.

For example, in some companies the focus is on improving the collection of receivables when others streamline their procurement process to reduce their inventories.

Tools download:

Excel tool which allows to calculate the normative WCR and to determine what will be the WCR with the evolution of the turnover of your company.

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Last comments

Ovi Sicwetsha - 23/01/2018
This is useful.
sherjeel - 08/05/2017
Its good to have such a nice tool.

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