By Fernando Guedes.
Managing the need for working capital in the short term is a matter of utmost importance to the business of any company, be it small, medium or large.
In order to finance projects, grant payment schedules for its clients, develop stockholding policies, and negotiate term for payment of suppliers, the manager should always be aware of the fact that the amount of available cash is sufficient to honor his commitments, without the need to use short-term credit lines, such as overdraft facilities.
What is Working Capital?
Working capital represents the total amount of resources demanded by the company to finance its operational cycle. It is characterized by its degree of volatility, explained by the short duration of its elements and the constant mutation of the circulating assets. The flow of current assets occurs uninterruptedly in the operational activity of a company, as illustrated below:
Why is it Important to Manage Working Capital?
According to research by Sebrae-SP in 2015, 44% of entrepreneurs who claim to resort to some type of credit, resort to the use of overdraft, even though this is one of the most expensive credits available in the financial market. But why use overdrafts if there are so many cheaper and easily accessible credit lines to finance companies' working capital? Often this deficiency occurs because of the lack of short-term financial planning, which we will try to address in this article.
Many managers should ask themselves, at various times in their business, whether the amount of cash available will be sufficient to remedy their short-term obligations or whether the existing resources are more than necessary, generating implicit financial losses that could be enabling new planning.
The two situations are bad from the point of view of short-term financial management. For companies that store more resources for working capital than necessary, end up having the opportunity cost, as these resources could be invested in new projects or financial investments, which would bring more return than current account holders.
When dealing with companies that do not have sufficient working capital, the costs are clearer, as they end up using some short-term credit line, which will lead to interest payments, thus damaging the financial result of the business.
But with so many variables involved, is there any way to assess the quality of my company's working capital management? Yes. That's what we'll try to address next.
How to analyze the need for working capital?
Let's start by presenting some important concepts and indicators for performing this analysis:
Average Receipts Term - PMR
Refers to the payment term that, on average, is granted to its customers.
Some companies have a fairly conservative policy when it comes to granting term to their customers, and they often lose space for competitors who use a more aggressive deadline policy. So this is a very important indicator in the analysis that we are going to do, because the policy used in your business will directly influence the amount of resources that you will have to have at your disposal to honor your short-term commitments.
The PMR is calculated through a weighted average, where we calculate the terms granted to customers (usually in days) through sales figures.
PMR Calculation Example:
Considering the sales exposed below in a given period, how can we calculate the Average Receiving Period used by this company?
Using the concept presented, the PMR of this company can be calculated through the weighted average shown below:
Therefore, in the period studied, this company granted an average payment term for its customers, approximately 31 days.
Longer-term companies tend to need a larger working capital, which is sufficient to finance these deadlines without their monthly expenses being impaired.
Average Shelf Life - SME
Indicates the average term that the company's merchandise is stored until it is sold.
The SME calculation is carried out through the ratio between the variables: inventory and cost of goods sold (CMV), which can be obtained through Balance Sheet and from Statement of Income for the Year (DRE) of the company, respectively. This result should be multiplied by the analyzed period, for example: If the data refers to a month, we will multiply this ratio by 30, if we are dealing with semiannual data, multiply by 180, and so on.
PME Calculation Example:
Considering that a company, after calculating its monthly balance sheet, concludes that its inventory account is in the order of R $ 15.000,00, and also receives through its DRE that its cost of goods sold in the month was R $ 28.000,00. What is the average storage time used by this company?
Therefore, we can conclude that 16 days is the average term in which stocks stay in this company.
This index, like the others, is extremely important for the analysis of investment in working capital, since it enables the manager to verify possible inefficiencies in the stocking process. When a company has a very high average stocking term, it will generally need a larger working capital to keep those assets stalled until they are sold.
Medium Term Supplier Payments - PMPF
This indicator refers to the payment term that, on average, your suppliers grant you.
The calculation of the PMPF is performed by the ratio of the following variables: existing supplier debts and the cost of goods sold (CMV), which can be obtained through Balance Sheet and from Statement of Income for the Year (DRE) of the company, respectively. This result should be multiplied by the analyzed period, for example: If the data refers to a month, we will multiply this ratio by 30, if we are dealing with annual data, multiply by 360, and so on.
PMPF Calculation Example:
Considering that a company, after calculating its monthly balance sheet, concludes that there are debts in the order of R $ 35.000,00 with suppliers, and also receives, through its DRE, that its cost with goods sold in the month was R $ 28.000,00. What is the average term of payment of suppliers obtained by this company?
Therefore, this company has an average vendor payment term of approximately 32 days.
Companies that have small payment periods for their suppliers generally will need a larger working capital when compared to companies that have the longest time to make their payments.
Need for Turnover - NIG
It is the minimum value that the company must have in cash to enable its entire operation, without it being necessary to resort to the contribution of resources by its partners or the use of short-term credits.
The NIG is calculated by the difference between the cyclical assets and the cyclical liabilities, according to the formula below:
Writing in another way:
Example of Calculation of NIG:
Considering a company that has a turnover in the order of $ 35.000,00 monthly, and based on the values found in the previous examples as being part of the operational cycle of this company. What is the amount needed for working capital of this company? Should it invest or withdraw funds from your cashier?
Therefore, we can conclude that for the company not to have short-term working capital problems, it must have at least the amount of R $ 17.500,00 to maintain its operations, without the need for third-party capital or even even from the provision of equity.
Important information about Working Capital Need
Companies in some segments, due to the nature of their activities, have the interference of seasonality in their operating cycles, ie, these businesses may require more or less working capital, depending on the time of year. Companies that make chocolate, for example, are demanded by the market in a much more aggressive way at Easter time, completely changing their operating cycles during this time of the year.
Therefore, it is extremely important that the manager, in addition to monitoring these indexes and deadlines on a monthly basis, must pay attention to the context in which his / her company is inserted, aiming to adapt and apply these indicators in the best possible way, verifying in which periods of the year needs to provide resources for working capital, and what periods it can withdraw funds to invest in other projects or financial applications. Companies that are in the process of great growth, may also have their operating cycles quite changed over time, demanding greater attention to these deadlines and policies.
Another important aspect is analyzing, and always reviewing, the credit policy that has been applied by the company to the detriment of its financial demands and the competition. Although the strategy for managing working capital is very simple: shortening receipt periods and increasing payment terms, the manager should be aware of the demand of his clients and their suppliers, so as not to be changed by deadlines and more attractive credit policies in the market.
The strategy of short-term financial management should also be aligned with its medium- and long-term strategies, as each company has its objectives and goals to be achieved, and this can be hampered or delayed by erroneous short-term decisions.