Financing products
A trading company is planning to increase sales. Orders are growing, but the business also needs to purchase more inventory and wait longer for customer payments. Suppliers do not always offer equally long payment terms.
The business owner knows that growth will require additional funds. What is less clear is whether the company needs PLN 50,000, PLN 100,000 or a significantly larger amount.
Working capital requirements should not be estimated solely on the basis of revenue or the company's bank balance. It is necessary to determine how much capital is tied up in inventory and receivables, and how much of that requirement is covered by deferred payments to suppliers.
Only then can the company calculate how its capital requirements may change as the business grows and whether additional financing is actually needed.
This guide explains a simple formula, provides a calculation example and shows how to interpret the result.
What are working capital requirements?
Operating working capital requirements show how much capital a business commits to its day-to-day operating cycle.
In a simplified model, the calculation is based on three components:
- Inventory - materials, products and goods held by the business.
- Trade receivables - amounts owed by customers for which the business is awaiting payment.
- Trade payables - amounts the business owes suppliers for purchased goods or services.
Inventory and receivables increase working capital requirements because funds remain tied up in the company's operations.
Trade payables reduce the requirement in this model because the company can pay its suppliers at a later date.
For example, a company purchases goods, stores them for several weeks and then offers its customer a 30-day payment term. During that period, part of its capital remains tied up in inventory or receivables.
The higher the value of inventory and receivables relative to trade payables, the greater the company's operating working capital requirements may be.
If the main issue is cash tied up in manufacturing, see our related article: Cash Tied Up in Production - How Should Industrial Companies Calculate Their Capital Needs?.
Are net working capital and working capital requirements the same thing?
No. The two concepts are related, but they measure different things.
Net working capital is the difference between current assets and current liabilities.
Operating working capital requirements, on the other hand, focus on selected components of the operating cycle: inventory, trade receivables and trade payables.
The second approach helps assess how changes in sales, inventory levels and trade settlements affect a company's capital requirements.
However, it does not replace a full balance sheet or a cash flow forecast.
How to calculate working capital requirements: the formula
For a trading or manufacturing company, the basic model uses the following formula:
Trade payables are subtracted because deferred supplier payments partially finance the business's operations.
The result shows the level of operating working capital required at a particular point in time, not the amount of money the company is currently missing.
The business may already be financing this requirement through equity, retained earnings or other sources of capital.
What data do you need for the calculation?
Ideally, use figures from the same reporting date, such as the end of a month.
You will need:
- The value of inventory according to the company's accounting records.
- The balance of trade receivables.
- The balance of trade payables.
There are three important rules to follow.
First, the data must be comparable. You should not combine inventory figures from the end of September with receivables recorded at the end of October.
Second, check how VAT is accounted for. Inventory, receivables and payables may be recorded on different bases. The calculation should use consistent figures in line with the chosen methodology.
Third, trade payables do not include every liability the company has. The basic formula does not automatically deduct loan instalments, taxes or other items simply because they are classified as current liabilities.
If the company has a complex manufacturing process, significant advance payments or other specific accounting arrangements, the simplified model may need to be expanded with support from its accounting team.
Example: calculating working capital requirements
Consider a company that sells equipment to other businesses. It purchases goods from suppliers, stores them in a warehouse and offers deferred payment terms to B2B customers.
At the end of the month, the company prepares the following figures.
We assume that the figures are comparable and have been prepared using a consistent method. For this example, other operating items are excluded.
Substituting the figures into the formula:
PLN 180,000 + PLN 240,000 - PLN 150,000 = PLN 270,000
How should you interpret the PLN 270,000 result?
It does not mean that the company needs a PLN 270,000 loan.
The result indicates how much capital is tied up in the operating items included in the calculation after accounting for deferred supplier payments.
The company may already have sufficient capital to cover this entire requirement.
This is why the calculation alone is not enough to make a financing decision.
A more useful next step is to determine how the figure may change in the future.
How much additional working capital is needed when sales increase?
Suppose the same company plans to expand its operations.
To support higher sales, it will need more inventory. The value of invoices awaiting payment will also increase. At the same time, suppliers agree to increase the value of purchases made on deferred payment terms.
Let's compare the current position with the forecast.
The new requirement is:
PLN 260,000 + PLN 340,000 - PLN 190,000 = PLN 410,000
The difference compared with the current position is:
PLN 410,000 - PLN 270,000 = PLN 140,000
The planned increase in sales therefore raises operating working capital requirements by PLN 140,000.
This is an important figure for the business owner. It shows how much additional capital may become tied up in the operating items included in the calculation.
However, it does not mean that the company must obtain exactly PLN 140,000 through a loan.
If the business has sufficient surplus cash, it may be able to finance the growth itself. If it also faces significant additional expenses, its external financing needs may be greater.
The next step should therefore be to compare the change in working capital requirements with the company's actual financial resources.
Conservative scenario - what happens if inventory and receivables increase further?
A calculation based solely on planned sales growth may be too optimistic.
It is therefore worth preparing a second scenario that takes less favourable operating conditions into account.
Assume that:
- Trade receivables increase to PLN 400,000 because customers pay later than expected.
- Inventory increases to PLN 280,000 because the company needs to maintain a larger safety stock.
- Trade payables remain at PLN 190,000.
Under the conservative scenario:
PLN 280,000 + PLN 400,000 - PLN 190,000 = PLN 490,000
Compared with the current requirement of PLN 270,000, this represents an increase of PLN 220,000.
The difference between the base case and the conservative scenario is PLN 80,000.
The company may therefore have to commit PLN 80,000 more to inventory and receivables than initially expected under its growth plan.
This illustrates why it is useful to consider at least two scenarios when making financial decisions: the expected case and a conservative alternative.
However, the company should not automatically increase its loan application by the entire difference. It must first determine whether and when the additional working capital requirement will translate into an actual cash shortfall.
How to interpret positive, negative and changing working capital requirements
The calculation result alone does not always provide enough information to assess a company's position.
It is important to consider both whether the result is positive or negative and how it changes over time.
Positive working capital requirements
A positive result means that, under the chosen model, the combined value of inventory and receivables exceeds trade payables.
This is not automatically a sign of poor liquidity.
A company may deliberately maintain substantial inventory levels and offer customers deferred payment terms while financing its operations from its own capital.
Negative working capital requirements
A negative result means that trade payables exceed the combined value of inventory and receivables.
For example, this may occur in a business that sells goods quickly, receives customer payments almost immediately and pays its suppliers later.
A negative result does not automatically indicate good financial health. It may also reflect an accumulation of overdue payables, which requires separate analysis.
Increasing working capital requirements
An increase in the figure may be a natural consequence of business growth.
However, it may also indicate slower inventory turnover, longer collection periods or shorter payment terms granted by suppliers.
In this situation, it is worth identifying which component is responsible for the change, rather than treating the entire increase as a single problem.
Should you use month-end figures or averages?
Figures from a single date are a useful starting point, but they may not represent a company's typical working capital requirements.
For example, a business may receive a large delivery of goods just before the end of the month or collect a significant payment from a major customer.
The result calculated for that date will be correct for the selected figures, but it may differ considerably from the company's position during the rest of the period.
To assess changes more reliably, consider using:
- Figures from successive months, calculated using the same methodology.
- Average inventory, receivables and payables balances over comparable periods.
- Separate calculations for periods of high and low seasonal activity.
Consistency is essential. For example, an average inventory balance for an entire quarter should not be combined with a single month-end receivables balance without explaining the difference in the measurement periods.
In seasonal businesses, a single annual average may also conceal periods of particularly high capital requirements.
For financing decisions, it is therefore worth examining not only the typical amount of capital tied up in operations but also the expected peak requirement.
How do you turn working capital requirements into a financing amount?
At this stage, three different figures must be distinguished:
- Current operating working capital requirements - the amount of capital already tied up in the operating components being analysed.
- Forecast change in working capital requirements - the additional capital that business growth may require.
- Actual cash shortfall - the amount of money the company will lack at a particular point after taking available cash, planned inflows and expenses into account.
In our example, the forecast increase in working capital requirements was PLN 140,000.
Now assume that the company has PLN 40,000 in surplus cash that it can safely allocate to this purpose without reducing its required cash reserve.
If all other inflows and expenses were already covered, the simplified difference would be:
PLN 140,000 - PLN 40,000 = PLN 100,000
This is still not the final financing amount.
The business needs to establish when inventory and receivables will increase, when supplier payments will fall due and when customer payments are expected.
It must also account for expenses outside the basic model, including salaries, taxes and instalments on existing debt. Care should be taken not to count the same cash outflows twice.
The final financing amount should be based on the largest justified cash shortfall and the company's realistic ability to repay.
Detailed planning of cash inflows and outflows is a separate topic. For guidance on monitoring business finances regularly, read Weekly Financial Analysis for Businesses - 7 Signals Worth Monitoring.
When should a business consider financing from PaveNow?
If the calculation identifies a specific need for additional capital, the company can compare available financing options.
Depending on the purpose and source of repayment, a business growth loan or financing for a particular contract or receivable may be worth considering.
Not every positive working capital requirement means that a company needs to take out a loan. The business must first establish which resources already finance its operations and how much additional cash it actually needs.
The available amount and terms depend on an individual assessment of the business. Information about one financing option is available on the PaveNow Growth Loan for Businesses page.
Checklist - is your working capital calculation complete?
Summary - what do working capital requirements really tell you?
Operating working capital requirements help determine how much capital a business commits to inventory and receivables after taking trade payables into account.
The calculation itself is simple, but its greatest value comes from comparing figures and interpreting changes.
In our example, the company's initial working capital requirement was PLN 270,000.
Planned growth increased this figure to PLN 410,000, an additional PLN 140,000. Under the conservative scenario, the requirement rose to PLN 490,000, representing an increase of PLN 220,000 from the initial position.
These figures indicate how much capital is tied up in operations. They do not automatically represent the amount the company needs to borrow.
First, calculate the current requirement. Then estimate the forecast change. Only after that should you determine the actual need for additional financing.
This approach allows business owners to make decisions based on data rather than estimating financing needs solely from growing sales or the current bank balance.
