What is Days Working Capital?
The Days Working Capital (DWC) reflects the operational efficiency of a company by estimating the time required to convert working capital into revenue.
By closely monitoring and implementing tactics to optimize its days working capital, a company can reduce its liquidity risk and improve its free cash flow (FCF).
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How to Calculate Days Working Capital (DWC)
The days working capital (DWC) is an accounting metric used to determine a company’s liquidity risk, or ability to fulfill its near-term obligations using its cash on hand.
Simply put, the days working capital metric counts the number of days required by a company to convert its working capital into sales (and thus, the DWC ratio offers insights into the efficiency at which a company allocates its working capital to generate revenue).
From the perspective of a company’s management team, apart from the initial upfront purchase of fixed assets (PP&E)—recognized on the cash flow statement (CFS) as a “Capital Expenditure” (or Capex), the other reinvestment activity required for business continuity is working capital.
The first step to calculate a company’s days working capital starts off with determining the working capital balance at the beginning and end of a given period.
The working capital of a company is calculated as the difference between current assets and current liabilities in a given period.
- Current Assets ➝ Cash and Cash Equivalents, Accounts Receivable (A/R), Inventory
- Current Liabilities ➝ Accounts Payable (A/P), Accrued Expenses, Notes Payable
Because seasonality can cause fluctuations in working capital in certain industries, like the retail sector, the days working capital metric is most often computed on an annual basis to normalize the metric.
Upon determining the value of the two figures, the next step is to calculate the average working capital by calculating the sum of the beginning and ending working capital balance and dividing the result by two.
Once complete, the net revenue (or “top line”) is obtained from the income statement, otherwise referred to as the profit and loss (P&L) statement. The net revenue figure represents the total income generated by the company from the sale of its goods or services over the course of a year, or trailing twelve months (TTM).
By dividing a company’s net revenue by its average working capital balance, and then multiplying by 365—the number of days in a year—the days working capital (DWC) can be determined.
The steps to calculate the days working capital (DWC) metric are as follows:
- Step 1 ➝ Determine the Working Capital at the Beginning and End of the Period
- Step 2 ➝ Calculate Average Working Capital
- Step 3 ➝ Retrieve Annual Net Revenue From Income Statement
- Step 4 ➝ Multiplying the Resulting Figure by 365 to Convert to Days
Days Working Capital Formula
The formula for days working capital divides a company’s average working capital by its net revenue, which is then multiplied by 365, the total number of days in a fiscal year.
Where:
- Average Working Capital = (Beginning Working Capital + Ending Working Capital) ÷ 2
- Net Revenue = Gross Revenue – Returns – Discounts – Sales Allowances
The average working capital is used here because the denominator, net revenue, is recorded on the income statement and represents the sales generated across two periods.
In contrast, the working capital items—such as accounts receivable (A/R) and accounts payable (A/P)—are recognized on the balance sheet, which reflects the outstanding value as of the reporting date (“snapshot”).
Therefore, the average working capital must be used to ensure consistency in the time frame covered in the numerator and denominator, reflecting a more accurate picture of the company’s short-term financial health and operational efficiency.
The rationale for multiplying the result by 365 is to convert the metric into units of days, so the output becomes standardized and can be compared to the industry benchmark to evaluate whether management is running the business efficiently or not.
However, for analyzing the operational efficiency of a company, using the operating working capital (OWC) metric is the more practical approach.
The only distinction is the removal of cash and cash equivalents and debt (and interest-bearing securities) from the working capital metric.
What is a Good Days Working Capital Ratio?
In short, the more time required by the company to convert its working capital into revenue, the less free cash flow (FCF) generated, as more cash is tied up in the day-to-day operations of the business.
That said, companies with lower days working capital (DWC) are viewed more positively, since that implies less time is required to convert working capital into revenue.
On the other hand, a higher days working capital (DWC) suggests the needs for more time to convert its working capital into revenue, and is thereby run less efficiently.
- Low Days Working Capital (DWC) ➝ Greater Operational Efficiency
- High Days Working Capital (DWC) ➝ Less Operational Efficiency
By tracking the pattern in a company’s days working capital (DWC) across time, management, and stakeholders like equity analysts can identify trends in its operating performance.
However, comparisons of the DWC metric must remain within the same industry (or sub-industry) for the derived insights to be useful.
Why? The companies that operate within a particular industry each have distinct business models, so the standard benchmark must be consistent.
Furthermore, the underlying drivers of the change in a company’s days working capital (DWC) must be determined, which is where much of the actionable insights are obtained from an insider’s perspective.
But for external stakeholders, the days working capital (DWC) metric can be compared across a peer group of comparable companies to identify which company’s operational performance leads the market (and those with lackluster performance).
On the topic of performing liquidity analysis, the days working capital (DWC) can be applied to understand a company’s short-term liquidity risk.
Like earlier, a lower days working capital (DWC) is preferred, as that signals the company has sufficient current assets to cover its near-term liabilities (and vice versa).
Conducting variance analysis for internal purposes consistently is recommended to understand the deviations between forecasts and actuals, which points out the variance drivers causing the change, for the company to implement adjustments to improve forecast accuracy over time.
How to Improve Days Working Capital (DWC)
Strategy | Description |
---|---|
Inventory Management Optimization (DIO) |
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Cash Collection Optimization (DSO) |
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3rd Party Payment Optimization (DPO) |
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Days Working Capital Calculator — Excel Template
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Days Working Capital Calculation Example
Suppose we’re tasked with measuring the operational efficiency of a company using the days working capital (DWC) metric given the following financial data.
Selected Financial Data | 2022A | 2023A | 2024A |
---|---|---|---|
Net Revenue | $400 | $440 | $462 |
% Growth | – | 10.0% | 5.0% |
Current Assets | |||
Cash and Cash Equivalents | $80 | $85 | $100 |
Accounts Receivable (A/R) | $20 | $25 | $30 |
Inventory | $60 | $65 | $70 |
Total Current Assets | $160 | $175 | $200 |
Current Liabilities | |||
Accounts Payable (A/P) | $40 | $45 | $60 |
Accrued Expense | $10 | $15 | $20 |
Short-Term Debt | – | $5 | $10 |
Total Current Liabilities | $50 | $65 | $90 |
To reiterate from earlier, the working capital component can either focus on analyzing the operating performance, or liquidity risk.
In our illustrative exercise, we’ll choose to focus on the operational performance of our hypothetical company.
Therefore, we’ll exclude cash and cash equivalents and short-term debt from our calculation of working capital.
For each year—from 2022A to 2024A—we calculate the operating working capital (OWC).
2022A
- Current Assets (Excluding Cash) = $20 million + $60 million = $80 million
- Current Liabilities (Excluding Debt) = $40 million + $10 million = $50 million
- Operating Working Capital (OWC) = $80 million – $50 million = $30 million
2023A
- Current Assets (Excluding Cash) = $25 million + $65 million = $90 million
- Current Liabilities (Excluding Debt) = $45 million + $15 million = $60 million
- Operating Working Capital (OWC) = $90 million – $60 million = $30 million
2024A
- Current Assets (Excluding Cash) = $30 million + $70 million = $100 million
- Current Liabilities (Excluding Debt) = $60 million + $20 million = $80 million
- Operating Working Capital (OWC) = $100 million – $80 million = $20 million
Given the operating working capital (OWC) for each period, the subsequent step is to calculate the average working capital using the “AVERAGE” function in Excel.
- Average Working Capital (2023A) = $30 million
- Average Working Capital (2024A) = $40 million
In closing, we’ll divide the average working capital by net revenue, and then multiply by 365 to determine the days working capital (DWC) of our company, which comes out to 25 and 20 in 2023 and 2024, respectively.
- Days Working Capital (DWC), 2023A = ($30 million ÷ $440 million) × 365 = 25 Days
- Days Working Capital (DWC), 2024A = ($40 million ÷ $462 million) × 365 = 20 Days