Financial Modelling

• Publish Date : December 6, 2017 Category Name
  • Leasing
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Financial Modelling

You may be wondering, however, what is working capital?

Working capital is the funds a company has for its day-to-day activities. It can also be described as the company’s current position, where if we take all of its current assets, convert them to cash and pay off all of its liabilities– then whatever is left – positive or negative – describes the company’s current liquidity position. The firm should have enough cash left to support itself. If the figure is negative, it means that the business cannot sustain itself. On the other hand, if you end up with a large positive figure, it may indicate that the company doesn’t maintain its working capital sufficiently enough and is too cash heavy.

The formula for calculating working capital is very simple:

Working Capital = Current Assets – Current Liabilities.

However, this is only simple to calculate if you have a balance sheet in place and know where to get these figures from. If you are, like us, just starting out and in the process of preparing one, how can you derive your working capital figure?

In this case you may need to;

1) identify the components of the working capital based on a monthly budget, and…

2) calculate these components based on the duration of the working capital cycle which reflects the delay in time that cash takes to arrive in/out of your bank account as we all understand that cash doesn’t always flow simultaneously in and out once the transactions take place.

From the formula above, you might have guessed that the working capital consists of the following accounts (=components):

• Accounts receivable – this is what is owed to the company for its services
• Accounts payable – this is what the company owes for the purchases it makes
• Accrued expenses – same as above, apart from these expenses will not yet be invoiced
• Prepaid expenses – these are prepayments made for purchases in advance

Working capital also includes inventory, as well as other current liabilities and other current assets. For the purpose of this blog, I will not include these, as I want to a) keep this simple, and b) some of these are not relevant for a fintech start-up such as NOW Money.

In order to estimate the working capital duration cycle, I will use the simplified operating cycle method, which takes into consideration the time it takes for each business operation to convert an asset or liability into cash.

Firstly, you’ll need to look at each line of your monthly budget and assign each one a component from the list above.

Secondly, you’ll need to consider how long it will take to pay bills/receive the money. I suggest you use 1 month to start with for most of your AP/AR.