How Much Working Capital Does Your Business Actually Need
- The operating cycle
- Worked, for a trading business
- Turning days into rupees
- Why the subtraction answer differs
- What actually moves the number
- Seasonality breaks the annual figure
- How a bank will assess the same question
- Gross and net, and which one people mean
- What to do with the number
- Where this fits
Working capital is not a number you guess and it is not simply current assets minus current liabilities. That subtraction tells you what you had on one day. It does not tell you how much cash your business needs tied up permanently just to keep operating.
The figure you actually want comes from your operating cycle, and it takes about twenty minutes to compute from statements you already have.
The operating cycle
Money leaves when you pay a supplier and comes back when a customer pays you. The gap between those two events, in days, is the cycle you have to fund.
Cash conversion cycle = inventory days + receivable days − payable days.
- Inventory days = (average inventory ÷ cost of goods sold) × 365
- Receivable days = (average trade receivables ÷ credit sales) × 365
- Payable days = (average trade payables ÷ credit purchases) × 365
Use averages of opening and closing balances rather than year-end figures. Year-end balances are the least representative day of the year in most businesses, because collections are chased and purchases deferred.
Worked, for a trading business
A distributor with annual revenue of ₹4,80,00,000, all on credit, and cost of goods sold of ₹3,60,00,000.
| Item | Opening ₹ | Closing ₹ | Average ₹ |
|---|---|---|---|
| Inventory | 52,00,000 | 60,00,000 | 56,00,000 |
| Trade receivables | 74,00,000 | 82,00,000 | 78,00,000 |
| Trade payables | 41,00,000 | 47,00,000 | 44,00,000 |
Assumes all sales and purchases are on credit, purchases approximate cost of goods sold, and trading is reasonably even through the year.
| Measure | Working | Days |
|---|---|---|
| Inventory days | (56,00,000 ÷ 3,60,00,000) × 365 | 56.8 |
| Receivable days | (78,00,000 ÷ 4,80,00,000) × 365 | 59.3 |
| Payable days | (44,00,000 ÷ 3,60,00,000) × 365 | 44.6 |
| Cash conversion cycle | 56.8 + 59.3 − 44.6 | 71.5 days |
Turning days into rupees
The cycle tells you how long your money is out. Multiply by what goes out each day.
Daily operating cost = (cost of goods sold + cash operating expenses) ÷ 365. If cash operating expenses are ₹66,00,000, that is (₹3,60,00,000 + ₹66,00,000) ÷ 365 = ₹1,16,712 a day.
Working capital requirement = 71.5 × ₹1,16,712 = ₹83,44,908, say ₹83.4 lakh.
That is the amount permanently tied up in the business at this level of trading. It is not a one-off. Grow revenue 25% without changing the cycle and the requirement grows to roughly ₹1.04 crore, which is why profitable businesses run out of cash while growing.
Why the subtraction answer differs
Current assets minus current liabilities on the closing balance sheet gives ₹60,00,000 + ₹82,00,000 − ₹47,00,000 = ₹95,00,000, ignoring cash. That is higher than the ₹83.4 lakh above, and it is a snapshot rather than a requirement.
The cycle-based figure is the one to fund and the one to plan against. The subtraction is useful only for spotting whether you are solvent on the day.
What actually moves the number
Each component is worth a different amount, and it is worth knowing which lever is largest before you pull any of them.
| Change | Effect on cycle | Cash released |
|---|---|---|
| Collect 10 days faster | −10 days | ₹11,67,000 |
| Hold 10 days less stock | −10 days | ₹11,67,000 |
| Take 10 days longer to pay | −10 days | ₹11,67,000 |
Arithmetically identical, commercially not. Collecting faster costs goodwill with customers. Holding less stock risks stockouts. Paying later is free until a supplier withdraws credit or a discount is lost, and then it is expensive: a 2% discount for paying in 10 days instead of 45 is an effective annual cost of roughly 21% if you forgo it.
In most businesses receivables are the softest target, because a portion of the balance is not a policy decision at all but simply invoices nobody has chased.
Seasonality breaks the annual figure
The calculation above assumes even trading. If two thirds of your revenue lands in one quarter, your peak requirement can be double the annual average and your trough can be near zero. Funding to the average leaves you short exactly when you are busiest.
For a seasonal business, run the cycle on the peak quarter’s figures, or better, build a rolling 13-week cash flow forecast which shows the shape rather than the average.
How a bank will assess the same question
Your computed requirement and a bank’s sanctioned limit are arrived at differently, and knowing the difference saves an argument.
For smaller limits, Indian lenders have long used a turnover-based approach: a proportion of projected annual turnover is treated as the working capital requirement, the borrower is expected to bring a margin from own funds, and the bank funds the rest. It is crude and it ignores your actual cycle entirely, which is why a business with unusually fast collections can find itself offered more than it needs, and a business with slow-paying institutional customers offered far less.
For larger limits the assessment moves to a projected balance sheet method, where the bank looks at your forecast current assets and current liabilities, applies its own view of acceptable holding levels, and funds the gap net of the margin it expects you to fund yourself. Here your cycle computation matters directly, because the bank is testing whether your stated inventory and receivable days are believable against your history and your sector.
The practical consequence is this. Bring the cycle computation, with the days shown and the averages visible. A limit request supported by 71.5 days of measured cycle is a different document from one supported by a percentage of turnover, and it is much harder to trim arbitrarily.
Gross and net, and which one people mean
Two terms get used interchangeably and should not be. Gross working capital is simply total current assets: the whole amount tied up in stock, receivables and short-term balances. Net working capital subtracts current liabilities and tells you how much of that is funded by long-term sources rather than by suppliers and short-term borrowing.
When a lender asks for your working capital requirement they usually mean the gross figure, from which they will deduct the credit your suppliers already give you. When your accountant discusses working capital they usually mean net. Establishing which is meant before quoting a number avoids a conversation at cross purposes.
What to do with the number
Compare it against what you have funded. If the requirement is ₹83.4 lakh and your sanctioned cash credit limit is ₹60 lakh with ₹10 lakh of own funds in the business, you are ₹13 lakh short and you are meeting that gap by stretching suppliers, whether or not you have called it that.
That is also the number a bank wants when assessing a limit, and presenting it computed rather than asserted changes the conversation.
Run your own figures through the working capital calculator.
Where this fits
- Your own figures: working capital calculator
- The short-horizon view: 13-week cash flow forecast
- Why profit and cash diverge: profitable but no cash in the bank
- Reading the statement this comes from: how to read a cash flow statement
- What your banker computes: TOL/TNW