What Is Days Working Capital?
Days working capital describes how many days it takes for a company to convert its working capital into revenue. The more days a company has of working capital, the more time it takes to convert that working capital into sales. The higher the days working capital number the less efficient a company is.
- Days working capital describes how many days it takes for a company to convert its working capital into revenue.
- Companies that take fewer days to turn working capital into sales revenue are more efficient than companies that take more days to generate the same amount of revenue.
- If the days working capital number is decreasing, it might be due to an increase in sales.
- Conversely, if the days working capital number is high or increasing, it could mean that sales are decreasing or perhaps the company is taking longer to collect payment for its payables.
Understanding Days Working Capital
Working capital, also known as net working capital, is the difference between a company’s current assetslike cash, accounts receivable, and inventories of raw materials and finished goods, and its current liabilitieslike accounts payable and the current portion of debt due within one year.
The difference between current assets and current liabilities represents the company’s short-term cash surplus or shortfall. A positive working capital balance means current assets cover current liabilities. Conversely, a negative working capital balance means current liabilities exceed current assets.
Working capital is a measure of both a company’s operational efficiency and its short-term financial health. Although working capital is important, days working capital demonstrates how many days it takes to convert working capital into revenue.
The more days a company has of working capital, the more time it takes to convert that working capital into sales. In other words, a high value of days working capital number is indicative of an inefficient company.
While negative and positive working capital calculations provide a general overview of working capital, days working capital provides analysts with a numeric measure for comparison.
A low value for days working capital could mean a company is quickly using its working capital and converting into sales. If the days working capital number is decreasing, it might be due to an increase in sales.
Conversely, if the days working capital number is high or increasing, it could mean that sales are decreasing or perhaps the company is taking longer to collect payment for its payables.
Days Working Capital Formula and Calculation
DWC=Sales revenueAverage working capital× 365where:Average working capital=Working capital averagedfor a period of timeSales revenue=Income from sales
Working capital is a measure of liquidity. Working capital is calculated by the following:
Working Capital=Current Assets−Current Liabilitieswhere:Current assets=Assets converted to cash valuewithin a normal operating cycleCurrent liabilities=Debts or obligations due withina normal operating cycle
- Calculate the working capital for a company by subtracting current liabilities from current assets.
- If you’re calculating days working capital over a long period such as from one year to another, you can calculate the working capital at the beginning of the period and again at the end of the period and average the two results. You could also calculate the working capital for each quarter and take an average of the four quarters and plug the result into the formula as average working capital.
- Multiply the average working capital by 365 or days in the year.
- Divide the result by the sales or revenue for the period, which is found on the income statement. You can also take the average sales over multiple periods as well. It all depends on whether you’re analyzing one period or multiple periods over time.
Limitations of Days Working Capital
As with any financial metricdays working capital does not tell investors whether the number of days is a good or poor number unless it’s compared with companies in the same industry. Also, it’s important to compare days working capital over multiple periods to see if there is a change or a trend.
Also, ratios can be skewed and produce murky results from time to time. If a company had a sudden surge in current assets in a period where liabilities and sales remained unchanged, the days working capital number would increase because the company’s working capital would be higher.
No investor would argue that having extra cash on hand, or current assets, would be a bad thing. For this reason, taking the average working capital and average sales over multiple quarters gives investors the most complete and accurate picture.
Example of Days Working Capital
A company makes $10 million in sales and has current assets of $500,000 and current liabilities of $300,000 for the period.
- The company’s working capital would equal $200,000 or $500,000 – $300,000.
- The days working capital is calculated by ($200,000 (or working capital) x 365) / $10,000,000
- Days working capital = 7.3 days
However, if the company made $12 million in sales and working capital didn’t change, days working capital would fall to 6.08 days, or ($200,000 (or working capital) x 365) / $12,000,000.
An increased level of sales, all other things equal, produces a lower number of days working capital because the company is converting working capital to more sales at a faster rate.
A company with a days working capital level of six takes twice as much time to turn working capital, such as inventory, into sales than a company with a days working capital of three for the same period.
In other words, a company with three days working capital is twice as efficient as a company with six days working capital. While the company with a higher ratio is generally the most inefficient, it is important to compare against other companies in the same industry, as different industries have different working capital standards.