How to calculate working capital requirement?
The formula for working capital calculation involves a simple subtraction of a company’s current liabilities from the total assets currently owned by it.
Some of the main constituents of the current assets of a company are:
1. Cash in hand that a company has.
2. The stock or inventory the company holds.
3. Debtors yet to pay their dues for purchasing goods from the company.
4. Expenses paid for in advance.
The current liabilities may comprise:
1. Outstanding payments to be made to creditors.
2. Other unpaid expenses.
3. Other short- term debts to be paid off.
Working capital Formula
Working capital of a business represents its liquidity status, i.e., its ability to meet short-term operational liabilities through assets convertible to cash. A business has adequate working capital when its current assets exceed the value of current liabilities by a healthy margin.
Ideally, a working capital ratio between 1.2 and 2 is considered adequate for a business’s optimum performance.
The formula for working capital calculation takes into consideration all current assets existing in business except cash. It is because available cash is the ultimate measure of liquidity and changes frequently with either receipt or payment. Adding it to the current assets does not portray an accurate picture of liquidity a business carries.
Other exclusions also affect the value of current assets and liabilities when calculating a concern’s working capital.
The working capital formula used for calculation is as follows.
Working Capital (WC) = Current Assets (CA) – Current Liabilities (CL)
Understand it with the help of an example –Total current assets of Raymon’s business stand at Rs.25,000. Total current liabilities are valued at Rs.45,000. The WC for Raymon’s business will be calculated as CA – CL. It equals Rs.25,000 – Rs.45,000., resulting in a deficit of Rs.20,000.
Know that an excess of current assets over current liabilities results in a WC surplus. On the contrary, an excess of current liabilities over current assets results in WC deficit as calculated by the above working capital formula. It indicates that the business’s short-term liquidity does not stand at an optimum. It also indicates that a business requires additional capital to optimise its day-to-day operations.
Also, consider the following exclusions and make adjustments during the working capital calculation.
• Cash commitments such as buyback of shares, declared dividends, etc. to be excluded from cash-in-hand.
Working Capital Calculation
• Exclude non-trade receivables such as loans to employees from total debtors.
• Exclude wasted, old or obsolete inventory from total stock.
Understand WC calculation with the help of the following illustration.
Say, your business has the following current assets:
• Goods sold on credit: Rs.2,00,000
• Raw Materials: Rs.1,00,000
• Cash in hand: Rs.3,50,000
• Obsolete inventory: Rs.40,000
• Loans given to employees: Rs.50,000
The total value of the current asset would thus be a sum of values given above, i.e., Rs.5,60,000.
The current liabilities include:
•Outstanding funds payable to creditors: Rs.2,70,000
•Unpaid expenses: Rs.80,000
The total value of current liabilities thus stands at Rs.2,10,000 (A sum of the above two values).
Now, using the working capital formula, you can estimate the business’s liquidity status.
WC = CA – CL
= Rs.5,60,000 – Rs.3,50,000
With this calculation, a business can estimate the amount of working capital it needs to allocate to other resources for optimum use. In the case of deficit, the concern can opt for a working capital loan to meet the expenditure requirements.
Bajaj Finserv brings a high-value loan of up to Rs.30 lakh to help a business fund its WC needs and operate at optimum efficiency. Avail the loan and repay affordably with competitive interest rates on offer.