Working Capital Cycle Calculator

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Working Capital Cycle


How Many Days of Sales Do You Need to Finance?

How Much Working Capital Do You Need?.

Tool for analyzing what-if scenarios.

If you currently own the business, enter the balance sheet amounts. Otherwise, just enter your annual sales, hit calculate, and tweak the forecasted days in the results section.

Projected Balance Sheet

Balance Sheet ItemAmountForecast (Days)
Accounts Receivable$40,000
Accounts Payable$15,000
Net Working Capital$65,000
Days of Sales49.43

Return on Working Capital

Line ItemAmountForecast (Amounts)
Contribution Margin$120,000
Average Investment$65,000
Return on Net Working Capital185%
Fixed Cost$75,000
Total Return$45,000
Total Return on Net Working Capital69%

Tool Overview: Working Capital Cycle Calculator

What is This and Why Does It Matter?

Almost every business needs a certain amount of cash to operate. You will (most likely) need to buy inventory and wait for either your customers or your payment processor to pay you. These are generally intended as short term investments, in the sense they will (hopefully) convert back into cash relatively quickly. Accountants call this "working capital". The term "net working capital" is the working capital of the business net of any credit you are getting from your current suppliers.

This tool, a net working capital calculator, gives you a view of of how well your business is using working capital. This is expressed as the number of days you would need to finance a dollar of sales. You can use this to run what-if scenarios for a new business or proposed improvements to an existing business. If you already own or can see a company's financial data, enter the balance sheet amounts and hit calculate - the working capital calculator will set up the analysis based on this information. For a completely new or hypothetical business, enter the expected annual sales and hit calculate - then edit the forecasting assumptions in the P&L below.

We include three additional metrics at the bottom. First, we calculate how many total days you need to finance a sale. Any improvements in this amount (turning inventory faster, getting paid quicker, squeezing suppliers for credit) reduces the amount of cash you need to run your business. Next, we look at your margin on sales to assess how much you are earning from your working capital investment. This is expressed as the gross profit of the business vs your working capital investment. Finally, we net out your expected fixed expenses (rent, owner salary, etc) to get a total return on your investment. The latter assumes you have not made additional investments in fixed assets or taken on long term financing such as a bank loan.

More Detail on Net Working Capital...

Almost every business needs a certain amount of cash to operate. Inventory must be purchased and held for a period of time. Customers must be billed and payment may not be immediate. Even if payment is immediate, such as with a credit card, there may be an additional period of time before the payment processor deposits the money in your account and releases it for use. Accountants refer to these funds as the working capital of a company.

Along the same lines, the company may get credit from its own suppliers. This can be used to offset some of these investments. We refer to the difference between the working capital a company invests and receives as the net working capital of the company.

Net working capital differs from other forms of corporate financing and investment due to the duration of the assets and debts involved. We expect to sell most of our inventory within a specific number of days. Similarly, most suppliers expect to be paid for their products in services within a relatively short time. This is usually 30 - 60 days and almost always less than a year. Longer term commitments are recorded in different accounts, such as long term debt or property / plant / equipment, unless the obligation has been accelerated and declared immediately due as a result of other events.

What Is Working Capital Management?

The art and science of controlling a company's use of short term funds is referred to as working capital management. This is generally addressed at two levels.

The first, controllership, deals with the creation of appropriate process controls and tracking mechanisms to ensure there are appropriate safeguards against unauthorized or imprudent spending and payments. This could include a company's purchasing policies, new item set up process, new vendor setup, customer credit approvals, payment collections efforts, and any approvals of expenses. It also includes the accounting processes required to track and report payments. Good controller-ship is a prerequisite for getting a handle on operating cash flow.

The second, working capital improvement deals with making systematic changes to the processes and polices used to manage working capital in hopes of operating the business more efficiently (with less working capital). For example, we could look at how we purchase products to increase the speed with which we turn over our inventory. Instead of buying full trucks from a manufacturer, perhaps we could pay a slightly higher cost for weekly shipments from a distributor? This policy change would reduce the average inventory level of the business, since we would be ordering more frequently and in smaller quantities.... reducing the swings in inventory levels over the course of the cycle. Along the same lines, if we can find a way to send out bills faster, we could shave a couple of days off the time required to collect payments from our customers. Both of these would serve to reduce the number of days of sales we need to finance, releasing cash which can be used elsewhere in the business.

Working Capital In a Turnaround Situation

Efficient management of working capital is particularly important if the company is going through financial distress and cannot fund their operations using a more traditional source such as a bank loan. Banks will often shut down lending at the first signs of trouble or uncertainly in the business. Existing investments in working capital can usually be converted to cash within a few weeks during the normal course of business and can provide funds to help stabilize the company.

Implications for Growth Businesses

Along the same lines, your need for working capital will likely increase as your business grows. If nothing else changes, you will have to finance more sales and need additional inventory to support this demand.

This is an area where a little enlightened working capital management can pay huge dividends. While accounts receivable typically grows as sales increases, this is an area where you can certainly be more selective in who you finance. You also want to avoid "becoming a bank" to your customers or - at a minimum - earn above average margins on customers who are buying only for credit. Inventory management and product assortment control is another key area - the same pile of inventory can get more efficient as demand increases. Higher demand usually means you can order more frequently and reduce the relative size of your investments in safety stock (as a % of sales). However, if all of this growth is coming from new products and spread out inventory piles (for example, in different cities), these benefits will not occur. Finally, the growth of your business often will allow you to approach suppliers for a better deal on pricing and credit terms. All of these can improve your return on working capital.

Negative / Infinite Return on Capital

Under certain circumstances, it is possible to have negative net working capital. This often requires you to convert working capital investments to cash very quickly (a fast credit card payment processor and just in time delivery) and to squeeze your suppliers to provide extended credit terms. Under these circumstances, any growth in the business will release capital to the owners due to the additional credit available from your suppliers. The supplier is basically financing your operations....

Content: Working Capital Cycle Calculator
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