Working capital and working capital requirement

Two ways to define working capital

The IBR-IRE study starts from an observation: net working capital measures overall the matching of maturities between assets and liabilities, and it can be defined in two ways.

From the top of the balance sheet, one compares durable resources with durable uses:

Net working capital = permanent capital − fixed assets

that is, in codes: (10/15 + 16 + 17) − 20/28. Permanent capital brings together equity, provisions and deferred taxes, and amounts payable after more than one year. If they exceed fixed assets, part of the current assets is financed by long-term capital, which ensures stable financing for the permanent stock of current assets that operations require.

From the bottom of the balance sheet, the same amount appears as the excess of current assets over short-term debts. This is the reading translated by the NBB broad liquidity ratio: positive net working capital is equivalent to a ratio above 1.

The IBR-IRE warns: positive net working capital hardly guarantees an overall balance of maturities, since it may be obtained through costly long-term borrowing financing a disproportionate stock of inventories and/or receivables. Hence the second concept.

The net working capital requirement

Operations generate by themselves a credit that the IBR-IRE calls spontaneous: the non-financial short-term debts (suppliers, advances received, taxes, remuneration and social security). This credit finances more or less completely the operating current assets (stocks and short-term receivables). Only the shortfall in spontaneous financing of operating current assets therefore requires financing by permanent capital, and is for that reason called the net working capital requirement.

Net working capital requirement = operating current assets − non-financial short-term debts

In full format codes: (3 + 40/41) − (44 + 45 + 46 + 47/48, excluding financial debts). FinScan analyses use a simplified version readable in every format: amounts receivable within one year (40/41) less trade debts (44) and taxes, remuneration and social security debts (45), stocks being added only when they are detailed.

The relation that explains cash

The IBR-IRE sums up the whole in one equation:

Net cash = net working capital − net working capital requirement

Net cash itself is read on the balance sheet: current investments and cash at bank (50/53 + 54/58) less financial debts within one year. Insofar as net working capital exceeds the net working capital requirement, the company shows positive net cash. In the opposite situation, the balance has to be financed through financial debts within one year: overdraft, straight loan, cash credit.

This is the equation to keep in mind. A company runs short of cash either because its long resources are insufficient (weak working capital), or because its business ties up too much money (high requirement). The two evolve according to two largely independent elements; the evolution of working capital alone therefore turns out to be only a partial indicator of liquidity.

Reading the working capital requirement over time

Relate the requirement to turnover when it is published, or to total assets otherwise, and compare with the previous year:

• A stable requirement: the business runs at the same pace.
• A requirement growing faster than the business: customers pay more slowly or stocks pile up. This is the profile FinScan calls "the Illusionist": profitable on paper, but cash is falling.
• A falling requirement: better collection, or suppliers paid later, which is not necessarily a good sign.

The delays that make up the requirement

The National Bank publishes the ratios that break down the working capital requirement. In the full format:

NBB ratio	Formula	What it measures
Turnover of stocks of raw materials and goods (no. 15)	60 ÷ (30/31 + 34 + 35 + 36)	How many times the stock renews itself in the year
Number of days of customer credit (no. 17)	(40 + 9150) ÷ (70 + 74 − 740 + 9146) × 365	Average delay to get paid
Number of days of supplier credit (no. 18)	44 ÷ (600/8 + 61 + 9145) × 365	Average delay to pay

The last two also exist for the abridged and micro formats, provided turnover (70) and purchases (60/61) are disclosed. The IBR-IRE recalls that the value of turnover ratios is hard to interpret in isolation: they are studied over time and against the sector.

For a supplier

If you sell to a company whose working capital requirement explodes and whose cash melts, your invoices risk being paid last: supplier credit is precisely the "spontaneous credit" that finances its cycle. The guide check a customer before signing shows how to take this into account in your terms.