Working capital requirements - what is it and how is it calculated »
Working capital requirements

Working capital requirements - what is it and how is it calculated

Restoration was the example we chose for creating a business. We covered several plans until it was time to analyze and plan the investment in working capital needs and the respective calculation formula.

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Summary of the path we have taken

Catering business
Catering business And also see...

Step by step, we saw what the Business model which would be the most appropriate, we estimated the sales plan to which variable manufacturing costs would be associated and we thus advanced in the elaboration of the business plan.

We exemplified with the possible investments in fixed assets, we evaluated the raw material costs (CMVMC) necessary costs and the fixed costs of the activity, which we call Supplies and external services.

We calculated the labor cost, in line with the strategy advocated for our human resources.

The time has come to analyze working capital needs.

Exploration results

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We saw previously that the Operating Result, in the first year, is €27.947.

Operating Result, Year 1
Operating Result, Year 1

We therefore have an idea of ​​how this example of an entrepreneurial project works, in economic terms.

We return to the beginning of our reflections, with what we foresee to invest in this business.

Capital requirements for investment

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In summary, we present the table with the investments that we considered necessary.

Fixed Capital Investment
Fixed Capital Investment

The table shows that the initial capital required for the project is €20.000.

What are working capital needs

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Working capital needs occur because, normally, there is a gap between payments and receipts.

We need money to be able to pay and maintain a stock of products and materials, as well as to pay our employees and suppliers. Of course, we also receive money from our customers and it is this difference that constitutes the Working Capital Requirements (NFM), whose formula:

NFM = Stocks + payments to suppliers and employees - Receipts from Customers

It therefore corresponds to the amount necessary for the company to operate.

It is therefore a way of investing, but not in fixed capital. It is not to invest in tangible or intangible assets, which are called “fixed assets”, but it is capital necessary to finance the exploration cycle, an investment in current assets, as they are also referred to.

We can consider that any company needs a “financial cushion” to face unforeseen events in the treasury and liquidity, such as delays in receipts from customers or unforeseen advances in payments, whether to suppliers or the State.

It is therefore a form of investment, but in working capital.

The catering business has working capital needs
The restaurant business needs working capital. Interval!

The necessary starting capital

From the previous table, it follows that we need €20.000, of which €15.000 to invest in fixed assets (subject to depreciation and amortization) and €5.000 in miscellaneous expenses, amortized in a single year.

We then need to calculate what the working capital needs are.

To evaluate them, let's go to the annual costs which we have already found out:

Production costs 30.225€

Supply and External Services 32.284€

Labor 44.179€

O monthly value (annual value divided by 12 months) is €8.890.

Once here, we need to think about the financial cushion, that is, the working capital we want to have.

If we want to have a month, to face imponderables, the result is found.

However, we can think that in the first few months of the business, sales may not be achieved and we will have to pay salaries, have raw materials in stock and with fixed costs, to be paid monthly, regardless of what we sell.

Let's admit that we want to have a working capital investment of 2 months. It will be €17.781.

Investment in Fixed and Working Capital
Investment in Fixed and Working Capital

The investment plan is ready.

How can we manage working capital

The working capital can be increased or decreased, depending on the risk that we are willing to accept.

A simplistic way to reduce this is to keep stock levels very low, but do we want to take that risk in this business?

However, let us leave this discussion for later.

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