What is negative WCR: and how can it be managed?

WCR is an essential indicator in the life of a company. Calculating it can lead to negative WCR positive or zero.

How should this result be interpreted? What does a negative WCR mean, and how can it be optimized and maintained? We tell you all about it in this article.

Reminder of what WCR (working capital requirement) is and how it is calculated

WCR stands for Working Capital Requirement. WCR stands for Working Capital Requirement.

Definition

By definition, WCR corresponds to the cash flow gap in a company i.e. the time lag between incoming and outgoing payments . This time lag must be financed to enable the company to operate.

In day-to-day operations, a company's cash inflow may be lower than its cash outflow at a given point in time. There are several reasons for this:

• When making a sale or a transaction, the he customer usually doesn't pay the invoice immediately. The French Commercial Code provides for a default payment period of 30 to 60 days after delivery of the goods or services. In practice, however, according to the Observatoire des délais de paiements' 2022 report, the average late payment was 11.7 days.

These late payments result in a real negative impact on a company's cash flow, and in particular on its WCR.

In order to produce its products or services, the company has had to make purchases or investments. This results in cash outflows or expenses. This situation creates a cash flow gap, as the company does not immediately receive cash after making sales or providing services.

• Inventories accumulated by the company are not sold immediately. The longer this period (inventory turnover), the greater the impact on WCR.

Although inherent to business life, these timing differences create a financial need that must be financed.

How is it calculated?

A company needs to keep a constant eye on its WCR, not only from the outset, but throughout its existence. Before setting up a company you need to estimate your WCR. This means one of the most important calculations in drawing up your business plan.

In fact, a poor estimate of working capital can have a detrimental effect on your company's longevity. According to the figures, a poor estimate of working capital is the reason why about 50 % of companies close their doors before reaching 5 years of existence.

Likewise, throughout its existence, you need to calculate WCR periodically and regularly . You must then compare, analyze and interpret the results to identify any weaknesses or areas for improvement in your business.

There are various formulas for calculating WCR. Here is one of them:

WCR = Average inventories + Average trade receivables - Average trade payables

Concrete example of calculation

Here's a concrete example of how to calculate WCR to illustrate what we mean.

Here's an example of an Alpha company:

• Sales excluding VAT: 450,000 euros

• Sales including VAT (20%): €540,000

• Purchases as a percentage of sales excluding VAT: 52% or 234,000 euros (280,800 euros)

• Customer payment terms: 35% within 30 days and 65% after 60 days

• Supplier payment terms: 40% within 60 days and 60% after 30 days

• Average duration of raw materials inventories: 1 month of purchases excluding VAT

• Average duration of finished goods inventories: 7.5 days of sales excluding VAT

Here's the calculation:

1. Raw materials inventories :

234,000 euros x 1/12 months = 19,500 euros

1. Finished goods :

450,000 euros x 7.5/365 days = 9,246.57 euros

1. Trade receivables :

95% x 30 days = 28.5 days

5% x 60 days = 3 days

Total: 31.5 days' sales incl. VAT

540,000 euros x 31.5/365 days = 46,602.73 euros

1. Supplier credit :

10% x 30 days = 3 days

90% x 60 = 54 days

Total: 57 days

280,800 euros x 57 days/365 days = 43,850.95 euros

WCR = (19 500 + 9 246,57 + 43 850,95 ) - 43 850,95 = 28 746,57 euro

This means that the company must finance its working capital requirements.

What does negative WCR mean?

Most companies have a positive WCR. However, due to their characteristics and mode of operation, some sectors have a generally negative WCR.

A negative WCR is a sign of a company's financial health . This means that there is no no time lag between disbursements and receipts. In other words, the company does not need to find additional financing beyond its own resources. It cashes its customers before paying its suppliers. As a result, it has sufficient resources to cover its day-to-day expenses.

This is called "working capital resource not need in this case. This scenario is mainly encountered for companies using cash payment systems like supermarkets, for example.

Calculation example

Let's take the previous example of the Alpha company, this time with the following data:

• Purchases as a percentage of sales excluding VAT: 42%.

• Customer payment terms: cash (100%)

• Supplier payment terms: 75% in 30 days and 25% in 60 days.

• Average duration of raw materials inventories: 1 month of purchases excluding VAT

• Average duration of finished goods inventories: 3 days of sales excluding VAT

Here's the calculation:

1. Raw materials inventories :

234,000 euros x 1/12 months = 19,500 euros

1. Finished goods :

450,000 euros x 3/365 days = 3,698.63 euros

1. Accounts receivable :

0 euro because the company pays cash

1. Supplier credit :

75% x 30 days = 22.5 days

25% x 60 = 15 days

Total: 37.5 days

280,800 euros x 37.5 days/365 days = 28,849.31 euros

WCR = (19 500+ 3 698,63 +0 ) - 28 849,31 = -5 650,68 euro

What are the advantages of negative WCR?

Negative WCR means that the company has a cash surplus . This implies :

• Less need to borrow . Unless it needs to fund a financing project, it has no need to go into debt. This translates into lower operating costs, as there are few interest charges to pay.

• Lower risk of failure. The risk of default is lower, since the company has an indirect source of financing.

• Greater freedom of action . The entrepreneur can be the master of his own decisions, since his company operates with his own funds.

How to optimize working capital so that it remains negative?

A negative WCR is already an ideal solution for any company. To maintain this situation, you can act on a number of fronts:

• Optimize inventory management. We've already mentioned the importance of stock rotation. Dormant stock represents a cost for a company, and thus increases working capital. You need to carry out regular inventories to avoid overstocking. Also remember to reduce procurement and customer delivery times.

• Negotiate longer payment terms with suppliers. Outstanding trade payables also play an important role in maintaining negative WCR. In fact, they are an integral part of the formula. It is necessary to ensure that you collect before paying your suppliers. And don't accept advance payment. Pay attention to delivery times, too. You need to be able to clear your stock quickly. Hero which allows you to pay your suppliers much later.

• Streamline payment of social security and tax debts. For example, if you owe VAT, it's best to pay it monthly.

In which sectors/industries do you find negative WCR?

There are some sectors where WCR will always be negative. This is particularly the case when suppliers are paid on credit, whereas payments are made in cash. The most common examples are retail and foodservice.

How to optimize working capital with factoring and BNPL?

Factoring and BNPL are two effective methods for optimizing working capital.

Affacturage

Factoring is a legal-financial technique that enables a company to subcontract the collection of its receivables to a specialized company, the factor.

The company then receives a cash advance to finance its WCR. It is therefore a technique to be favored when the company is faced with a high positive WCR, i.e. a cash shortage.

In return, the factor receives a commission in proportion to the amount of the receivable.

If you're looking for a factoring solution, look no further. Hero. This is a payment solution that offers deferred payment.

How does it work? You buy from your suppliers. Hero advances your invoices to your suppliers on your behalf. Hero acts as a factor.

It is then up to the company to reimburse us after 30 to 60 days.

This technique enables the company to pay for purchases later . This will enable the company to adjust its cash flow to avoid an increase in working capital requirements. In the meantime, it may be able to collect cash from its customers, thus avoiding a time lag with disbursements.

Buy now pay later

The BNPL system allows a company to pay for a purchase in instalments. This system offers many advantages, including the possibility of attracting more customers. BNPL enables customers of limited means to purchase your offer. It also helps to optimize the customer experience and increase the average shopping basket.

Hero is also buy now pay later, allowing you to pay for your purchases in 3 or 4 instalments . This allows you to optimize your WCR, because you don't have to disburse payments all at once.

In other words, by staggering your payment, you don't create too big a gap in your cash flow.

On the other hand, Hero pays your suppliers in cash as soon as the purchase is confirmed. This system makes it possible to protect your business relationships with your partners.

In conclusion, it's in a company manager's interest to monitor WCR in order to keep an eye on the company's financial health. Reaching a Negative WCR is a good sign. But it only applies to certain sectors. To limit your WCR, adopt Hero and its BNPL and factoring options.

Other articles on the same subject:

• Reverse factoring: what is it?

• Business cash loans: optimize your cash flow

• Revenue based financing: what exactly is it?

• How to finance and optimize working capital requirements?

• Positive WCR: what is it and how can it be optimized?

• 2023 business loan rates [+ Guide to negotiating].

• 2024 business loan rates (and how to negotiate)

• Alternative financing: everything you need to know from A to Z