What is Days Working Capital?
Days Working Capital is a vital ratio considered for fundamental analysis of the company, which indicates number of days (lower the better) a company requires to convert its Working Capital into the sales revenue and is derived from Working Capital and the annual turnover.
The formula is as follows:
Important Definitions
- Working Capital: The difference between the Current Assets and Current Liabilities of the company 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 cycle is considered as Current Assets. e.g. Inventories, Cash and Cash Equivalents, Trade Receivables, Prepaid Expenses, etc.
- Current Liabilities: The liabilities which are due for payment in one operating cycle is known as Current Liabilities — e.g. Trade Payable, Outstanding Expenses, Bills Payables, etc.
- Operating Cycle: The Operating cycle is the time required by an entity to reach from the initial stage of purchasing of raw materials to realize the cash from the Trade Receivables. The operating cycle varies from company to company and considered lower the better as the company is quite efficient in achieving the cash invested in Working Capital. It is also known as the Cash Conversion cycle.
- 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’s say we are considering the ratio for a year; hence, we could take the average of working capital on the opening and closing date of the year. Also, we could go further and take quarters instead of opening and closing dates for our calculations.
- Operating Working Capital: Operating Working Capital denotes subtraction of Operating Liabilities from the Operating Assets. Those Current Assets and Liabilities which are used or directly contribute to the operations of the company are known as Operating Assets and Liabilities.
The formula for Operating Working Capital is as follows:
A few examples of operating items are Fixed assets; Plant and Machinery (involved in the production), Inventories, Trade Payables & Receivables, Cash blocked for operating purposes, etc. Cash earmarked for investments, Marketable securities, and other such assets or liabilities would not be considered for calculation of Operating Working Capital.
In some organizations, if, there is a substantial presence of Non-Operating assets or Liabilities, or bifurcation for non-operating amounts is readily available, this method could be used.
In the following example, we are assuming that Other Current Assets and Other Current Liabilities are non-operating in nature. So, these are not considered for the calculation of Operating Working Capital.
Days Working Capital Examples
Below are the examples of days working capital.
Example #1
Let’s take the annual numbers of Microsoft Corp. as on 30th June 2019 for the calculation of the Days Working Capital. Revenue of $ 125,843 million, Current Assets, and Current Liabilities of $175,552 million, and $69,420 million respectively.
Solution
Below is given data for calculation of days working capital
Calculation of Working Capital
Working Capital = Current Assets – Current Liabilities
- = $175552-$69420
- = $106132
- =($106,132 * 365) / $125,843 million
- = 307.83 days.
It indicates the entity’s ability to convert the working capital to the Revenue in approximately 308.
Example #2
Let’s 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.
Solution
Below is given data –
Calculation of Net Working Capital
- =$180000-$100000
- Net Working Capital = $80000
Calculation of Days Working Capital
- =($80000*360)/$200000
- = 144 days
Here in the above example, as we can see, the Days working Capital is 126 days, and that denotes the company has the ability to recover its total invested working capital in 144 days.
Example #3
In the following example, we are assuming that Other Current Assets and Other Current Liabilities are non-operating in nature. Revenue for the particular period is $ 2,00,00,000. Take 360 days in your calculation. Calculate Days and Net Operating Working Capital
Solution
Below is the given data –
Calculation of Operating Working Capital
- =$150000-$80000
- Operating Working Capital = $70000
Calculation of Days Working Capital is as follows –
- =($70000*360)/$200000
- = 126 days
Here in the above example, as we can see, the Days working Capital is 126 days, and that denotes the company has the ability to 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 realizations from the revenue from sales. So, if the resultant number is lower, it is considered better.
- This ratio helps the analysts to consider the company with a better cycle of funds along with the efficiency of the operations of the business.
Disadvantages
- The ratio does not clearly explain anything if we consider the result as an absolute number. Because the Days to working capital varies from company to company and industry to industry. Also, it heavily depends upon the nature of the business. For example, if a company has a trading business, it would have a much lower ratio in comparison to 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 and to go to the individual items of Assets and Liabilities to measure its impact on the overall ratio. If we don’t do that, it is quite possible that 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 as it reflects the ability to sell products has increased.
- 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 the cursory glance, this situation seems reasonable, but the end result is negative. Excess Cash in the books denotes a lack of opportunity to invest funds in future ventures. Similarly, a growing Accounts Receivable 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 Days Working Capital Ratio turns out to be 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. Though it gives a clear picture of the capabilities of the organization to convert initial investments to the realization of Revenue, it becomes difficult to understand due to the involvement of multiple variables.
Recommended Articles
This has been a guide to Days Working Capital. Here we discuss the calculation of days working capital along with its formula, examples, advantages, and disadvantages. You can learn more about excel modeling from the following articles –
