Understanding working capital requirement

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18 / Aug / 2009

In simple terms, working capital requirement is the amount of funds required by a business to meet its short-term obligations – over the next 12 months. To do so, you need to manage your stock, work in progress, outstanding customer amounts and outstanding supplier amounts.

The way to minimise working capital requirement is to reduce the length of time stock sits on the shelf; minimise the length of time that jobs spend in progress, and minimise the length of time customers take to pay. It also helps to maximise the length of time available to pay suppliers. In order to meet these objectives you need systems and processes in place to constantly manage these factors.

A common fallacy is that if a business sells more, working capital will take care of itself. A problem arises when these factors are not managed and the cash gets tied up in stock, work in progress, customers and suppliers etc. You can have great difficulty paying costs such as wages, superannuation and meeting other overheads. High working capital requirement will bring a business undone far quicker than low profit