The working capital budget is essential for its proper management and, more importantly, for reviewing how it will be financed if necessary. It is an indispensable input for cash flow management and the preparation of the cash budget. The vast majority of companies do not pay enough attention to it, and yet, spending more time analyzing each of its components often reveals the origin of most liquidity problems.
What is working capital?
In general terms, working capital —or operating fund— is the difference between current assets and current liabilities: the resources that the company has to finance its operations.
WORKING CAPITAL = CURRENT ASSETS − CURRENT LIABILITIES
When working capital is positive, the company has the necessary resources to cover its short-term obligations: a sign of good financial health. If it is negative, it may indicate financial difficulties and short-term liquidity problems.
Net operating working capital (NOWC)
The net operating working capital, or NOWC, focuses the analysis on the accounts that directly influence the company’s operating activity, excluding non-operational current assets:
NOWC = ACCOUNTS RECEIVABLE + INVENTORIES − ACCOUNTS PAYABLE
- Accounts receivable: amounts owed by customers for sales or invoiced services.
- Inventories: raw materials, work-in-process, and finished goods directly related to the activity.
- Accounts payable to suppliers: cash commitments to third parties for goods or services received.
How to read this indicator
- A lower NOWC is usually better, as it implies that the company needs less cash to operate, as long as sales are growing.
- A negative NOWC is not necessarily a bad sign: it is normal in models such as retail, which finances high-turnover inventories with suppliers to whom it pays in over 30 days, while its sales are in cash.
- It is essential to monitor the effect of decisions that modify the cash cycle. For example, extending the payment term to customers from 30 to 60 days may boost sales, but it also means financing an additional 30 days of receivables.
Why budget for it?
- Because sales growth requires more inventory and more credit to customers, creating a gap between billing and collection that needs to be covered.
- To avoid cash strain, overdrafts, and unexpected loans.
- Because it improves the ability to anticipate liquidity needs, allowing treasury to plan ahead for the most cost-effective sources of financing.
How to integrate it with the rolling forecast
- Every time the rolling forecast is updated, the projected working capital must be recalculated.
- Project the working capital movements in each update to anticipate cash needs or surpluses.
- Rely on historical ratios —days sales outstanding (DSO), days inventory outstanding (DIO), and days payable outstanding (DPO)— to project it with greater accuracy.
- Simulate scenarios with changes in receivable turnover, inventory, or payment terms.
Common mistakes to avoid
- Not considering proportional increases in working capital when sales grow.
- Underestimating the impact of changes in commercial terms.
- Not recalculating working capital in each rolling forecast cycle.
Clarus Tip: Planning sales without anticipating working capital is like building a building without foundations. The working capital budget should become an ally of financial planning, not a surprise that disrupts the path.
At Clarus Consultores, we help you project your operating working capital and anticipate your liquidity needs before they become a problem. Let’s talk about your company’s working capital.