Working Capital Calculator – Demystifying what working capital means for your business | Reap

Working Capital Calculator – Demystifying what working capital means for your business


4 min read

The general definition of working capital is the amount of money used for financing the day-to-day operations of a business. However, what does this definition actually mean in practice? Is it the amount of money in the bank account of your business? Is it the amount sitting in the cash register? Or do you require an accounting degree and all your cash flow statements and balance sheet to figure out what exactly working capital means for your business?

Working Capital Calculator – Demystifying what working capital means for your business

Because these questions are rarely answered for small business owners, we here at Reap have created a simple calculator to tell you more about your working capital. The calculator needs eight simple data points to get a general picture of where the business is right now. And then the calculator will provide you some findings.

In this article, we want to help you understand exactly what these results and numbers mean. And what steps you can add to your business plan to find more capital for growth.

1. Gathering some information

Before you get started, all we need is eight simple pieces of information to proceed.

  1. Last month’s sales
  2. Last month’s cost of goods sold
  3. Current inventory
  4. Inventory last month
  5. Current receivables
  6. Receivables last month
  7. Current payables
  8. Payables last month

Don’t worry if you don’t have these details right away, you can come back anytime to use the calculator. The numbers don’t also have to be exact. The purpose here is to give you a high-level view of where you are at right now. Whether or not you have completed the calculator, we can dive deeper into exactly what we are calculating, and how it’s relevant to your business.

2. Understanding the numbers

The calculator will tell you an average cash conversion cycle for your operating activities. This metric means how long it takes between you spending cash to prepare for selling your goods, until when you’re able to collect cash back from selling that good or service.

Why does this relate to working capital? Because the cash conversion cycle represents the time your cash is stuck as working capital, and you are unable to keep that cash on hand for other purposes such as growth and re-investments. So imagine a cash conversion cycle of 150 days, meaning every dollar you put in for your business, you won’t be able to use it freely for five months!

What can be done to improve this number and, have faster turnover of cash without hurting your business? We look at the three components of the cash conversion cycle.

a. Days of Inventory Outstanding

This metric means the cash value of your inventory, and the amount of time that is required on average to convert back into cash. This is important, because if this is too long, that means you have very high amount of inventory that remains in storage for long periods without being sold.

If there isn’t a need to stockpile large amounts, you may consider reducing inventory or finding an alternate solution allowing to flexibly adjust as your business needs arises.

b. Days of Sales Outstanding

After the sale has been completed, you do not necessarily collect cash immediately, hence there is a receivable period. The Days of Sales Outstanding measures on average how long it takes for you to actually collect the cash from your customers.

The longer you don’t collect from your customers, the longer your working capital requirements will be, because you’re not getting cash fast enough. So consider options to demand payment faster from your customers, without impacting the relationship; perhaps monthly payments in instalments or other payment methods could be helpful.

c. Days of Payables Outstanding

The final component of the cash conversion cycle is how long you take on average to make payments to your vendors, suppliers, employees etc. The longer this metric is, the better it is for your working capital, because you are able to use cash for other purposes before any payments come due.

Negotiating longer supplier payment terms is a great way to extend this, or find a financing solution (eg. credit cards instead of bank transfers) for your expenses.However, it’s important to be careful, because sometimes vendors may demand payment upfront. It’s important to keep extra cash set aside to be ready to accommodate for unforeseen circumstances.

3. Identifying issues and changes

Now that you understand what the calculator is telling you about your working capital, we want to advise you on a few things before implementing changes towards any potential issues.

Everything is relative. Note that the number of days for each metric can be long or short depending on your business industry. For example, if your days of sale outstanding is 30 days, but everyone else in your industry is averaging 60days, that means you are doing a better job of collecting payments, quicker than competitors. This allows you to free up cash and grow faster.

But if the industry average is 15, then 30 days is not so good anymore, so you must understand the industry to compare them. Utilize your experience, and find a balance of which metric you can improve the most.

4. Key takeaways

A final disclaimer is that the calculator is based on the last month’s performance of your business. Certain industries, such as F&B or travel, will have seasonality, and will require you to consider which seasons will need more inventory, longer sales etc. This will impact your analysis.

Having enough working capital for your business to function day-to-day is most important for an SME.There will be situations that you even experience negative working capital meaning you are putting more cash into the business than taking out, even though you might have positive net income. In these scenarios, you may need working capital financing or loans to invest, even though the business is working well.

5. A more tangible example

Let’s say, you are running an e-commerce store selling your own designed Awesome T-shirts. You sell them for 50 HKD each, and order them from your supplier for about 30 HKD each.

So in the past month (30 days) your t-shirt business sold 10,000 Awesome T-shirts, which is about 500,000 HKD in sales. And the supplier cost of buying those T-shirts, were 300,000 HKD.

You like to keep some inventory on hand, in case your supplier can’t deliver them fast enough if you sell too much. Right now you have 10,000 shirts in storage. This means your inventory right now would be 300,000 HKD (recorded at the cost of the shirts). A month ago you had a bit more on hand because you expected to sell more T-shirts, around 20,000 shirts, so 600,000 HKD in inventory.

Of the 500,000 HKD you sold last month, you’re still waiting to collect 200,000 HKD, because the customer hasn’t paid you yet. This was the same a month ago. Your receivables typically do not change as I wait to collect money

For your supplier, you generally pay 50% upfront, so the rest you pay a bit later in around 30 days. Which means 150,000 HKD sits in your payables right now. Last month this was about the same too.

If you input all this information into the calculator, you’d get the following results.

· Your cash flow from operations was 500,000 HKD over the last month

……this means the total amount of cash that you brought into the business, not just the sales on record

· Your average days of inventory outstanding is 45

……this means the cash value of your inventory is stuck for an average of 45 days

· Your average days of sales outstanding is 12

……this means it takes on average 12 days for you to collect cash from any sale

· Your average days of payables outstanding is 15

……this means you take on average 15 days to pay your operational expenses

· Your cash conversion cycle is 42

……this means 42 is the average amount of days between starting to get supplies for your goods/service and collecting cash from the sale