Normative working capital

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.