Working capital requirements

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

Restoration was the example we chose, to create your own business and having a new successful entrepreneur. We have covered several plans, until the time has come when we have to analyze and plan the working capital needs.

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Summary of the path we have taken

Catering business
Catering business

Step by step, we saw what Business model which would be the most appropriate, we estimated the sales plan that would be associated variable costs manufacturing process and we were thus advancing in the business plan.

We exemplified with the possible investments in fixed assets, we evaluated raw material costs necessary and the fixed costs of the activity that 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

We saw earlier that the Operating Result in the first year, it 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

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

Working capital needs occur because there is usually a lag between payments and receipts.

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

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

It is therefore the amount necessary for the operation of the company.

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

We can consider that any company needs a “financial cushion” to deal with treasury and liquidity, such as delays in the receipt of payments from customers or unforeseen anticipations of payments either to suppliers or to the State.

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

The catering business has working capital needs
The catering business needs working capital

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 over a single year.

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

To assess, we go to the annual costs that we have already determined:

Production Costs - € 30.225

Supply and External Services - € 32.284

Labor - 44.179 €

The monthly fee is divided by 12 months, that is 8.890 €.

Here, we need to think about the financial cushion, that is, the working capital, that 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 months of the business, sales may not be reached and we will have to pay wages, have raw materials in stock and we have fixed costs to be paid monthly, regardless of what we sell.

Let's admit that we want to have a 2-month working capital. 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 it is to keep stock levels very low, but in this business do we want to take that risk?

However, let us leave this discussion for later.

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