Days Working Capital Definition Formula Calculation

What are Days Working Capital?

Days working capital is a vital ratio considered for fundamental analysis of the company, which indicates the number of days (lower the better) a company requires to convert its working capital into sales revenue. One may derive it from working capital and the annual turnover.

The formula is as follows:-

Days Working Capital Formula = (Working Capital * 365) / Revenue from Sales.

Important Definitions

Working Capital: The difference between the company’s current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more and current liabilities of the companyCurrent Liabilities Of The CompanyCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more is known as working capital. The formula for working capital is as follows: –

Working Capital = Current Assets – Current Liabilities

Current Assets: Assets that could be realized, used, or extinguished in a normal operating cycleOperating CycleThe operating cycle of a company, also known as the cash cycle, is an activity ratio that measures the average time required to convert the company’s inventories into cash.read more are considered current assets. e.g., inventories, cash and cash equivalents Cash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more, trade receivablesTrade ReceivablesTrade receivable is the amount owed to the business or company by its customers. It is also known as account receivables and is represented as current liabilities in balance sheet.read more, prepaid expensesPrepaid ExpensesPrepaid expenses refer to advance payments made by a firm whose benefits are acquired in the future. Payment for the goods is made in the current accounting period, but the delivery is received in the upcoming accounting period.read more, etc.Current Liabilities: The liabilities due for payment in one operating cycle are known as current liabilities — e.g., trade payable, outstanding expenses, bills payables, etc.Operating Cycle: The operating cycle is the time an entity requires to reach the initial stage of purchasing raw materials to realize the cash from the trade receivables. The operating cycle varies from company to company and considers lower as the company is quite efficient in achieving the cash invested Cash InvestedCash investment is the investment in short-term instruments or saving account generally for 90 days or less that usually carries a low rate of interest or the return with a comparatively low rate of risk compared to other forms of investment.read more in working capital. It is also known as the cash conversion cycleCash Conversion CycleThe Cash Conversion Cycle (CCC) is a ratio analysis measure to evaluate the number of days or time a company converts its inventory and other inputs into cash. It considers the days inventory outstanding, days sales outstanding and days payable outstanding for computation.read more.Average Working Capital: If we are considering a longer span for working capital, it is better to take the average of working capital to remove the unevenness in the posted figures, if any. Let us say we are considering the ratio for a year. Hence, we could take the average working capital on the opening and closing dates of the year. Also, we could take quarters instead of opening and closing dates for our calculations.Operating Working Capital: Operating working capital denotes the subtraction of operating liabilities from the operating assets. Those current assets and liabilities that are used or directly contribute to the company’s operations are known as operating assets and liabilities.

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The formula for operating working capital is as follows:

Operating Working Capital = (Operating Current Assets – Operating Current Liabilities)

Examples of operating items are fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more; plant, and machinery (involved in the production), inventories, trade payables and receivables, cash blocked for operating purposes, etc. Cash earmarked for investments, marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company’s balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more, and other such assets or liabilities would not be considered for calculating operating working capital.Examples of operating items areExamples of operating items are fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more; plant and machinery (involved in the production), inventories, trade payables, and receivables, cash blocked for operating purposes, etc. Cash earmarked for investments, marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company’s balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more, and other such assets or liabilities would not be considered for calculating operating working capital.

If there is a substantial presence of non-operating assets or liabilities in some organizations, or bifurcation for non-operating amounts is readily available, one could use this method.

The following example assumes that other current assetsCurrent AssetsOther current assets refer to the category of assets which record all the uncommon and insignificant assets readily convertible into cash and doesn’t fit in any common current assets categories like cash & cash equivalents, inventory, trade receivables, etc.read more and liabilities are non-operating. So, these are not considered for the calculation of operating working capital.

Days Working Capital Examples

Below are examples of days working capital.

Example #1

Let us take the annual numbers of Microsoft Corp. as of 30th June 2019 to calculate the days working capital. Revenue of $ 125,843 million, Current Assets, current liabilities of $175,552 million, and $69,420 million, respectively.

Solution:

Below is given data for the calculation of days working capital

Revenue: $125,843Current Assets: $175,552Current Liabilities: $69,420

Calculation of Working Capital

= $175552-$69420= $106132.
=($106,132 * 365) / $125,843 million= 307.83 days.

It indicates the entity’s ability to convert the working capital to revenue in approximately 308.

Example #2

Let us take into consideration the following figures and calculate days working capital. Revenue for the particular period is $ 2,00,00,000. Take 360 days in your calculation.

Below is the given data:-

Calculation of Net Working Capital

=$180000-$100000Net Working Capital = $80,000

Calculation of Days Working Capital

=($80000*360)/$200000= 144 days

In the above example, as we can see, the working capital is 126 days, which denotes the company can recover its total invested working capital in 144 days.

Example #3

In the following example, we assume that other Current assetsCurrent AssetsOther current assets refer to the category of assets which record all the uncommon and insignificant assets readily convertible into cash and doesn’t fit in any common current assets categories like cash & cash equivalents, inventory, trade receivables, etc.read more and liabilities are non-operating. Revenue for the particular period is $2,00,00,000. Take 360 days in your calculation. Calculate days and net operating working capital.

Calculation of Operating Working Capital

=$150000-$80000Operating Working Capital = $70000

Calculation of Days Working Capital is as follows –

=($70000*360)/$200000= 126 days

In the above example, as we can see, the working capital is 126 days, which denotes the company can recover its total invested working capital in 126 days.

Advantages

It is a good indicator of the operational efficiency of the company. It entails the number of days the company would require to realize its initial investments in the working capital to realize the revenue from sales. So, if the resultant number is lower, it is considered better.This ratio helps the analysts consider the company with a better cycle of funds and the efficiency of the business’s operations.

Disadvantages

If we consider the result an absolute number, the ratio does not clearly explain anything. Because the days’ working capital varies from company to company and industry to industry, it heavily depends upon the nature of the business. For example, a company with a trading business would have a much lower ratio than the businesses involved in the manufacturing process.It is also challenging to predict the correct direction of the company because it involves multiple variables in the numerator, such as various current assets and liabilities. To get the real picture, we need to dig deeper into the individual assets and liabilities items to measure their impact on the overall ratio. If we do not, one or two heavyweight indicators could manipulate the ratio and reflect the non-fair picture.

For instance, the ratio could be lower because of the following reasons: –

Increase in the Revenue from Sales: It shows a better indication of increased sales ability to sell products.Delay in the Accounts Payable: It is also a good sign because this generally happens due to the reliable bargaining power of the entity and reflects a weakness on the part of the creditors.Inflated Cash or Accounts Receivables: Though in a cursory glance, this situation seems reasonable, the result is negative. Excess cash in the books denotes a lack of opportunity to invest funds in future ventures. Similarly, a growing accounts receivable Accounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year.
read more also indicates the inability of the company to demand dues from the debtors. This situation generally stems from the lack of bargaining power and the presence of inferior or slow-moving products.

Conclusion

Overall, the working capital ratio is an essential measure for checking the efficiency and effectiveness of capital investment in the operating process of the business. It helps the investors/analysts to compare the companies of similar standing based on better usage of funds and operating cycle. However, though it gives a clear picture of the organization’s capabilities to convert initial investments to the realization of revenue, it becomes difficult to understand due to the involvement of multiple variables.

What are Days Working Capital?#

Important Definitions#

Days Working Capital Examples#

Example #1#

Example #2#

Example #3#

Advantages#

Disadvantages#

Conclusion#

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