What is working capital?According to Brigham (1999), working capital is the company’s investment in short-term assets. According to Assaf Neto (2005), the concept of working capital or circulating capital is associated with the resources that circulate or revolve within the company over a given period of time. In other words, it is a portion of the company’s capital invested in its operating cycle. We call working capital the portion of a company’s own resources that we find available for applications.Working capital plays a significant role in companies’ operating performance, generally covering more than half of their total invested assets. Some factors, such as reduced sales, increased default rates, higher financial expenses, and increased costs, will be addressed in order to demonstrate the importance of good working capital management for the company.Working capital can help small businesses through a sound and effective economic strategy, so that the company has resources to invest in other ventures or even in the company itself. It is worth remembering that, when a company or organization begins operating, that is, functioning, the financial manager turns all their attention to working capital due to its importance, because it is due to a lack of control over the company’s cash inflows and outflows that most companies end up dying in such a globalized and competitive market.Because of the need to control this factor at all times, it is made clear that working capital is not the same as profitability, because the company’s profitability can wait for a recovery in profits. However, working capital cannot wait. It is a priority, that is, without profit the company becomes stagnant or shrinks, but without working capital, it disappears. This is because working capital is strongly influenced by the uncertainties inherent in every type of business activity.For this reason, the company should maintain a financial reserve to face any problems that may arise. The company must maintain the largest possible financial reserve to be allocated to the maintenance of working capital; as a result, the chances of financial crises will be lower. Therefore, the company is concerned with the amount of cash or cash equivalents it has.Cash and cash equivalentsCash equivalents are held for the purpose of meeting short-term cash commitments and not for investment or other purposes. For an investment to be qualified as a cash equivalent, it must be immediately convertible into a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short-term maturity, for example, three months or less, from the date of acquisition.Investments in equity instruments are not included in the concept of cash equivalents, unless they are, substantially, cash equivalents, as, for example, in the case of redeemable preferred shares that have a defined redemption period and whose term meets the definition of short term.Bank loans are generally considered financing activities. However, bank overdrafts arising from loans obtained through instruments such as overdraft facilities or guaranteed current accounts that are settled within a short period of time form an integral part of the entity’s cash management. In these circumstances, bank overdrafts are included as a component of cash and cash equivalents. A characteristic of these arrangements offered by banks is that balances often fluctuate from debit to credit.Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the entity’s cash management and not part of its operating, investing, and financing activities. Cash management includes the investment of excess cash in cash equivalents.How to reduce the need for Working CapitalIn addition to maintaining the financial reserve, the following measures will allow the elimination or prevention of insufficient working capital:▼ Control default: according to Assaf Neto (1997), default by a company’s customers may result from the country’s general economic situation or from factors within the company itself. In the first case, the general contraction of economic activity tends to increase default. In this situation, the company has little control over the problem. When default results from inadequate credit practices established by the company itself, the solution is less difficult. Basically, it will be necessary to pay more attention to the quality of sales than to their volume.▼ Do not finance working capital at any cost: according to Santos (2001), in an attempt to address insufficient working capital, many companies use high-cost loans. As a rule, any money raised at a cost greater than 1.17% per month (or 15% per year), in real terms, is compatible with the company’s normal profitability, which is 15% per year, also in real terms. Financing working capital at a real rate higher than 1.17% per month may solve the company’s immediate cash problem, but it creates another difficulty: debt repayment.▼ Extend the debt maturity profile: Santos (2001) notes that, when the company manages to negotiate a longer term for paying its debts, it postpones the corresponding cash outflows and, therefore, improves its working capital situation. Although the help is temporary, it will allow the company to wait for an improvement in its economic situation. In this case as well, it is important to pay special attention to the cost of extending the term. It must be supported by the company’s profitability.▼ Reduce costs: Brigham (1999) warns that implementing a cost reduction program has a positive effect on the company's working capital, as long as it does not bring restrictions to its sales or to the execution of its operations. Since a company with a working capital problem will also have its investment capacity compromised, cost reduction through processes such as modernization, automation, or computerization will not be possible. Faced with a working capital crisis, the cost reduction program is compulsory in nature, and its great challenge is to identify the expense items that can be cut without major losses to the company's activities.▼ Shorten the operating cycle: according to Gitman (2001), when the company shortens its operating cycle, its working capital needs are reduced.Calculating Working CapitalThe Working Capital value is calculated using the formula (it could also be called Net Working Capital):Current Assets – Current Liabilities(Accounts Receivable + Inventory) – (Accounts Payable)Optimizing Working CapitalThe need for working capital occurs when your Financial Cycle is positive (how much the company is uncovered):Financial Cycle (days) = Consumer payment (days) + product holding time (days) + Supplier delivery delay (days) + product production (days) - payment to supplier (days).We can use average values in order to calculate the Financial Cycle:- Calculate the average payment period for accounts payable: if 50% is cash and 50% in 30 days, the average is 15 days. Remembering that there may be other terms here;- Calculate the average collection period from customers: if one part pays in 30 days and another in 60, (30 + 60 = 90), the average collection period is 45 days.In other words, you have 45 days to receive payment from your customers and 15 days to pay suppliers. The result is that there are (45 – 15) 30 days of the operation to be financed by working capital.Does this mean that we need 100% of the money from "Accounts payable" sitting in the account for 30 days? Not exactly, because you may have to pay for 2 inventories, so you would need 200%, or you may receive from the previous customer at the moment you would pay for the next customer's inventory, meaning you would not need Working Capital.To make the calculations easier, we use the monthly amount spent with the supplier. If we need 10 thousand reais per month, then we need working capital of 10 thousand reais, since the Financial Cycle is 30 days (1 month).Example 1The commercial company's own working capital is 4 million reais. The company's financial cycle as a whole is 15 days, and the turnover at purchase prices is R$ 8,590,909. Thus, to work with suppliers and customers under the same conditions, the company needs 4,295,455 reais in working capital (8,590,909 reais times 15 days: 30 days). Therefore, the financing need to replenish working capital is 295,455 reais (4,295,455 - 4,000,000).Example 2Let's take the previous example. Suppose the company managed to increase the deferral of payment of contracts with suppliers by 3 days and, by the same amount, reduce the payment period for goods delivered to customers. In addition, it eliminated the delivery time loss - 5 days. Then the company's financial cycle will no longer be 15 days, but only 4 days. Consequently, the amount of working capital needed for the company's operating activities will be 1,145,455 reais (8,590,909 reais times 4 days: 30 days). This will eliminate the need for credit resources and, in addition, 2,854,545 reais (4,000,000 - 1,145,455) can be invested.Calculating the Financial Cycle of Complex OperationsCalculating the Financial Cycle when there is only 1 product and 1 supplier is easy, but imagine being part of a corporation with several products? In this case, we create a table with each product.NameSupplier payment timeConsumer payment timeDelivery timeTime storedFinancial CycleProduct 1303552131Product 245350144NameAmounts traded per monthFinancial CycleProduct 1R$ 1000031Product 2R$ 200004In this case, if you are conservative, you could add up the amount of Working Capital needed for each product to calculate the total Working Capital.Working capital needed for Product 1: R$ 10000*(31/30) = R$ 10333.33Working capital needed for Product 2: R$ 20000*(4/30) = R$ 2666.66Total: R$ 12999.99Note that you may end up leaving a lot of money idle; after all, the money that is idle for Product 1 could very well be used to pay for Product 2. Therefore, many discuss whether there can be a decrease in Working Capital as more products are handled.Exercises2) (FUNDATEC - 2018 - Municipality of Santa Rosa - RS - Tax Auditor) To answer this question, consider the values shown in the table below.Net Working Capital is equal to:A) R$ 500.00.B) R$ 3,000.00.C) R$ 3,500.00.D) R$ 4,500.00.E) R$ 5,500.00.3) (IBADE - 2018 - Vilhena City Council - RO - Financial Analyst - Administration) Working capital management includes current assets and current liabilities. The following is considered a current liability:A) accounts payable.B) marketable securities.C) inventories.D) accounts receivable.E) financial investments.4) (Quadrix - 2018 - CREF - 13th Region (BA-SE) - Administrative Assistant) Regarding financial management, judge the following item. Suppose that a company has non-current assets of R$ 230 million, non-current liabilities of R$ 170 million, and equity of R$ 150 million. In this case, the company's working capital is R$ 90 million.A) TrueB) False5) (VUNESP - 2019 - MPE-SP - Scientific Technical Analyst - Accountant) Regarding decisions related to working capital planning and management, it is correct to state:A) working capital decisions are related to financing an entity’s operating cycle.B) they are not relevant compared to decisions regarding the purchase of machinery and equipment.C) they do not involve the aspect of customer collection periods.D) considering all other variables static, the duration of the operating cycle has no relation to the entity’s result and to the required working capital.E) considering all other variables static, the longer the duration of the operating cycle, the lower the volume of required working capital.6) (CEPS-UFPA - 2023 - UFPA - Accounting Technician) A certain public entity, in the year 2022, collected R$ 100,000.00 in taxes and purchased a vehicle in cash for R$ 45,000.00 to use in its operating activities. It also contracted a credit operation in the amount of R$ 20,000.00 and carried out the settlement of the payroll in the amount of R$ 60,000.00. These events were provided for in the Annual Budget Law (LOA). Considering exclusively these events, select the correct alternative regarding the Statement of Cash Flows (DFC) applied to the public sector, according to the guidelines contained in the MCASP (2021).A) the net cash flow from investing activities is R$ 20,000.00.B) the net cash generation for the period was R$ 15,000.00.C) the net cash flow from operating activities is R$ 100,000.00.D) the net cash generation for the period was (R$ 25,000.00).E) the net cash flow from financing activities (R$ 25,000.00).Solution1) E2) B3) A4) A5) A6) B
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