Days Working CapitalDefined along with Formulas & How to Calculate

Written By:
Lisa Borga

What Is Days Working Capital?

The days working capital ratio is useful in the financial analysis of a company.

The ratio is a liquidity indicator that shows the number of days a company requires to turn its working capital into sales.

It is calculated by using the figures for annual turnover and working capital.

Days working capital helps to indicate how efficient a company is.

If a company has many days of working capital, it will take longer for the company to turn the working capital into sales revenue.

This would result in a higher number of days of working capital which tends to indicate an inefficient company.

Basically, an efficient company will have a low number of days working capital.

Explaining Days Working Capital

Working Capital, or as it is sometimes known, net working capital, indicates the amount of money a company has remaining after it subtracts its current liabilities from its current assets.

If a company has sufficient current assets to cover its current liabilities, then it has positive working capital.

Whereas, if the company’s current liabilities are greater than its current assets, it has negative working capital.

Working capital is helpful for analyzing the financial health of a company in the short term.

In contrast, days working capital indicates the number of days it takes a company to turn its working capital into sales.

This ratio helps investors to see how efficient a company is.

A company that has a large number of days working capital takes many days to convert its working capital to sales, which is a sign of an inefficient company.

Whereas a low number of days working capital is indicative of an efficient company.

Although, if a company’s days working capital is decreasing, it could be a result of increasing sales.

In contrast, if the ratio for days working capital is increasing, the company’s sales may be decreasing, or the company may be taking longer to collect its payables.

The Formula for Days Working Capital

Days Working Capital  =  (Working Capital x 365 days) / Revenue from Sales

Where:

Working Capital = Current Assets – Current Liabilities

Sales Revenue = Income From Sales

Important Terms

Working Capital

Working capital is a liquidity indicator.

It is the money a business needs to cover its daily operations.

It consists of the difference between a company’s current assets and current liabilities.

It also helps to indicate whether or not a company is in a good short-term financial position.

Current Assets

Current Assets are the assets of a company that are expected to be used or converted to cash within a normal operating cycle.

These are typically items such as cash, accounts receivable, inventory, and prepaid expenses.

Current Liabilities

Current liabilities are liabilities that are due to be paid within a normal operating cycle.

Current liabilities consist of accrued expenses, accounts payable, dividends payable, and short-term debt.

Operating Working Capital

Operating working capital is calculated by subtracting operating liabilities for a company from its operating assets.

A company’s operating assets and liabilities are the current assets and liabilities that it uses to contribute directly to its operations.

Operating Cycle

The operating cycle is the number of days it takes a company to receive goods and then receive cash from selling the goods.

Calculating Working Capital

First of all, the formula for calculating working capital is:

Working Capital = (Current Assets – Current Liabilities)

Working capital is calculated by subtracting the current liabilities of a company from its current assets.

If the working capital is being calculated for an extended period of time, such as for a year, the working capital can be calculated for the start of the year and then the end of the year and then averaged.

Another option for calculating working capital for an extended period is to compute the working capital for every quarter and then average the working capital for the four quarters.

Once the working capital is found, it is multiplied by 365 days.

Then, the result is divided by the sales revenue for the period.

The sales revenue for the period can be found on the income statement. 

Also, if several periods are being analyzed, average sales revenue for several periods could be used.  

Advantages and Disadvantages of Days Working Capital

Days Working capital is quite useful for analyzing a company’s short-term financial position.

However, it does have disadvantages as well.

Here are some of the advantages and disadvantages of the days working capital ratio.

Advantages

• Days working capital is a useful measure of a company’s operational efficiency. It gives the number of days a company requires to convert its working capital into revenue from sales.
• A lower days working capital number is considered better and tends to indicate the company is more efficient.

Disadvantages

• There is no definite good or bad days working capital number. It really depends on the industry a company is in as well as the nature of the business.
• The days working capital ratio is not useful for companies with negative working capital.

Days Working Capital Example

As an example of days working capital, consider the XYZ Manufacturing Company.

This company has total sales of $1,000,000 in its current accounting period and current assets of $700,000.

In the same period, it has a total of $200,000 in current liabilities.

Using these figures, the company can calculate its working capital.

To do this, the company subtracts its $200,000 in current liabilities from its $700,000 in current assets.

It will then multiply the resulting figure by 365 and divide it by its total sales revenue for the period of $5,000,000.

This results in a days working capital figure of 36.5.

Days Working Capital of 36.5 = [($700,000 – $200,000) * 365] / $5,000,000

Assuming that all other figures remain the same, then a higher level of sales will result in a lower number of days working capital.

This is because the company is successfully converting its working capital into sales at a higher rate.

For example, a company with 10 days working capital for a given period will take double the time to turn its working capital into sales as compared to a firm with 5 days working capital.

What this means is that the latter company with five days working capital is twice as efficient at converting its working capital into sales as the former company with ten days.

Though this can serve as a useful reference within a given industry, it is essential to keep in mind that comparisons of days working capital are only useful within a given industry.

Different industries often have considerably different norms regarding working capital, and as a result, useful comparisons of days working capital are generally impossible.

Key Takeaways

• Days working capital is a ratio that indicates the number of days a business requires to turn its working capital into sales.
• To calculate days working capital, it is necessary to know the average working capital and sales revenue.
• Businesses that require more days to convert working capital to sales are less efficient than businesses that take fewer days to turn working capital into sales.
• If a company’s days working capital ratio is decreasing, it could be a result of sales increasing.
• If a company finds that its days working capital ratio is increasing, it could be due to a decrease in sales or a longer collection time for its credit sales.
• It is important for a company to compare its days working capital ratio to other companies in the same industry as well as its own past ratios.