Days working capital definition
/What is Days of Working Capital?
Days working capital states the number of days required for a business to convert its working capital into cash. Thus, a higher days working capital figure means that a firm will require more days to realize cash from its working capital. A firm that requires fewer days to do so has a reduced need for financing, since it is making more efficient use of its working capital.
Working capital is all current assets minus all current liabilities, which are classified as such on the balance sheet. A positive working capital balance indicates that a business can pay for its immediate obligations, while a negative balance indicates that it will require extra financing in order to pay its bills on time. Businesses in the latter situation frequently use a line of credit to fund working capital shortfalls over the short term.
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How to Calculate Days of Working Capital
The days working capital formula is to derive the average working capital per day, and then divide by annual revenue. The formula is:
(Average working capital x 365 days) ÷ Annual revenue = Days working capital
How to Evaluate Days of Working Capital
The best way to determine how well a business is managing its working capital is to compare the days working capital figure to that of other companies within the same industry. It can also be useful to track it on a trend line to see if the figure is trending up or down over time.
Example of Days of Working Capital
A business carries an average balance of $500,000 of working capital, and its annual revenue is $6,000,000. Therefore, its days working capital calculation is:
($500,000 x 365) ÷ $6,000,000 = 30.4 days working capital
When to Use Days of Working Capital
Here are five scenarios where it makes sense for a business to use days of working capital as a measurement:
Managing cash flow in seasonal businesses. For businesses with significant seasonal fluctuations—such as retail stores during holiday seasons or landscaping companies in summer—days of working capital helps assess how quickly they can convert inventory and receivables into cash. A lower days of working capital figure during peak seasons indicates efficient cash flow management, ensuring they have sufficient funds to cover off-season expenses.
Evaluating efficiency in manufacturing. Manufacturing companies often hold large amounts of raw materials and finished goods. Days of working capital provides insight into how efficiently these businesses manage inventory and receivables relative to payables. A shorter days of working capital figure suggests that the company quickly turns inventory into sales and collects payments, minimizing the need for external financing.
Assessing liquidity for small businesses. Small businesses with limited access to external financing use the days of working capital measurement to monitor liquidity closely. A high days of working capital outcome could signal potential cash flow issues, prompting the business to tighten credit terms or expedite collections to maintain smooth operations without taking on debt.
Benchmarking performance in competitive industries. In industries like consumer electronics or fashion, where competition and turnover are high, businesses use days of working capital to benchmark against peers. A lower days of working capital figure compared to competitors indicates stronger working capital management, giving a potential edge in negotiations with suppliers or investors.
Preparing for a business expansion. Companies planning to expand—by opening new locations or launching new products—analyze days of working capital to ensure they have adequate cash flow to support growth. Efficient working capital management, reflected in a reasonable days of working capital figure, demonstrates the company’s ability to generate cash internally, reducing reliance on external funding.
By tracking days of working capital in these scenarios, businesses gain a clearer picture of their cash conversion efficiency and can make informed decisions about operations, financing, and growth.
Advantages of Days of Working Capital
There are a few benefits to using the days of working capital metric to evaluate a business, which are as follows:
Indicates operational efficiency. A business with a low days of working capital metric is likely well-run, able to maximize the use of its assets to generate sales. Thus, a low days of working capital measurement can be considered an indicator of good management.
Indicates funds usage. The days of working capital metric provides a good indicator to an outsider about how the management team of a business is using its funds. For example, if it indicates that a large amount of working capital is needed to generate sales, this indicates that the business has a strong need for funding, to support such a large amount of working capital. This can be important information for a prospective lender or creditor.