How to Calculate Your Working Capital Requirement

Why 'roughly enough' is not a number

Most business owners know they need working capital. Few know how much. 'Enough to cover a slow month' or 'whatever the bank will lend us' are not answers — they are substitutes for an answer that has not been calculated.

Working capital requirement is a precise, calculable number. It is the amount of cash your business needs to fund one full operating cycle — from paying for inputs to collecting from customers. If your actual working capital falls below this number, the business will eventually run out of cash, regardless of how profitable it is.

What to check

• Working Capital Requirement (WCR) = (DSO + DIO − DPO) × (Revenue ÷ 365)

What to check

• DSO (Days Sales Outstanding) = average number of days to collect from customers
• DIO (Days Inventory Outstanding) = average number of days inventory is held before sale — zero for pure service businesses
• DPO (Days Payable Outstanding) = average number of days you take to pay suppliers The result is the amount of cash permanently tied up in your operating cycle at your current revenue run rate.

What to check

A UAE distribution business has annual revenue of AED 6 million. DSO is 55 days (customers pay in 55 days on average). DIO is 30 days (stock turns in 30 days). DPO is 25 days (they pay suppliers in 25 days).

WCR = (55 + 30 − 25) × (6,000,000 ÷ 365) = 60 × 16,438 = AED 986,301

This business needs approximately AED 986,000 of working capital permanently available just to sustain its current operating cycle at current revenue. If it has less than this in available cash and credit, it is structurally underfunded.

What happens when you grow

Working capital requirement scales with revenue. If the business above grows revenue by 25 percent to AED 7.5 million without improving DSO or DPO, its WCR grows to approximately AED 1.23 million — an increase of AED 246,000.

This additional working capital must come from somewhere. If it does not — if the business grows revenue without securing additional working capital — it will begin to run out of cash despite growing profit. This is over-trading.

What to do

• Reduce DSO. Every 10-day reduction in DSO reduces WCR by approximately 2.7% of annual revenue. For a business with AED 6 million revenue, reducing DSO from 55 to 45 days saves AED 164,000 in required working capital. Increase DPO. Negotiating longer supplier payment terms reduces WCR dollar-for-dollar. Adding 10 days to DPO has the same effect as reducing DSO by 10 days.

• Reduce DIO. For businesses carrying inventory, reducing holding days by tightening purchasing to demand signals reduces the cash trapped in stock. Knowing your WCR gives you three things: the number to benchmark current available capital against, the model to forecast capital needs under growth, and the levers to pull when the gap is too large. Without the number, every decision about growth, borrowing, or distribution is made partially blind.

If this is your situation → use the Cash Runway Calculator.