A business’s working capital requirement is the cash tied up in running it at any given moment: inventory on the shelf, plus money owed by customers, minus money owed to suppliers. The arithmetic is simple. Inventory plus receivables minus payables. What the formula produces is a single number that most owners and most acquirers treat as the answer, and it is usually the wrong one.
The problem is that the requirement moves. It is a range, not a figure, and the number that matters is the top of that range rather than the middle. A business whose average requirement is $300,000 but whose seasonal peak reaches $420,000 needs the larger sum available, not the smaller. This is the reason a revolving facility sized to the requirement is generally more useful than a fixed sum drawn once: the requirement itself breathes, and funding that does not breathe with it leaves the business short at predictable moments.
The calculation
Take a business turning over $2.4 million a year, invoicing at $200,000 a month, collecting on average at 45 days, holding 30 days of inventory, and paying suppliers at 30 days. Assume cost of goods sold runs at 60 percent of revenue.
Receivables come to roughly $300,000, or a month and a half of billing. Inventory at 30 days of a $120,000 monthly cost of goods is about $120,000. Payables at 30 days offset roughly $120,000 of that. The requirement lands near $300,000, which is 12.5 percent of annual revenue.
That figure tells you how much cash the business consumes simply by existing at its current size. It earns nothing, appears nowhere on the profit and loss account, and has to come from somewhere.
Why the average is the wrong number
Three things push the real requirement above the calculated one.
Seasonality. Most businesses have a quarter where inventory builds ahead of demand and receivables peak after it. A business running 40 percent above average through its strong quarter needs closer to $420,000, and the $120,000 difference is invisible in an annual figure. Owners who fund the mean run short twice a year on a schedule they could have predicted.
Concentration. If one customer represents 40 percent of receivables, the requirement tracks one company’s accounts payable calendar rather than an average across many payers. When that customer moves from 45 days to 60, the requirement rises by a sum nobody authorized.
The lag between order and cash. Inventory bought today is billed in six weeks and paid in eleven. The requirement reflects decisions already made rather than current trading, which is why it responds slowly to cost cutting and quickly to a change in terms.
Execution explains more of the gap than industry does
It is tempting to treat the requirement as a fixed property of a sector. The evidence points elsewhere.
The Hackett Group’s 2025 U.S. Working Capital Survey, which analyzes the top 1,000 U.S. publicly traded nonfinancial companies, found $1.7 trillion trapped in excess working capital, equal to 35 percent of gross working capital and 11 percent of aggregate revenue, with an 18-day gap in days sales outstanding between top and median performers.
Those are large public companies rather than private mid-market businesses, so the figures are not a benchmark for a smaller operation. The useful part is the shape. An 18-day spread in collection performance between the best and the middle of the same peer group, at companies with dedicated treasury functions, says that the requirement is substantially a matter of how a business is run rather than what it sells. Whether the same spread holds further down the size curve is not something this survey measures, though smaller businesses generally have less process discipline to fall back on.
For anyone assessing an operating business rather than running one, that is the practical lesson. A high requirement often reflects a correctable operating position rather than a fixed feature of the industry, and the correction is worth real money.
What moves it
Four levers, in rough order of how quickly they work.
Collection discipline moves fastest. Invoicing on the day of completion rather than four days later, chasing at day 30 rather than day 45, and resolving disputes before they age all pull cash forward without renegotiating anything.
Supplier terms move next, though they take a relationship to shift. Every additional day of payables reduces the requirement by one day of cost of goods.
Inventory policy is slower and riskier, because cutting stock too far shows up as lost sales rather than as a line on a report.
Customer terms are the slowest and the most commercially sensitive, since shortening them is a price change by another name.
Funding the gap
Once the requirement is sized properly, the funding question becomes narrow. The peak minus the cash the business can hold on its own balance sheet is the gap, and the gap should be matched to a facility that flexes rather than a fixed advance.
Two errors are common. The first is funding the average, which leaves the business short at peak. The second is funding the peak with a term loan, which leaves the business paying for the full amount year-round when it only needs the full amount for part of it.
Imagine a business that sizes its facility at $150,000 against a $120,000 seasonal swing, draws it for four months and repays it across the following five. That is the shape the requirement actually has, and matching the instrument to the shape costs less than the alternatives.
Frequently asked questions
How do you calculate working capital requirement?
Inventory plus accounts receivable minus accounts payable. Calculate it at several points across a year rather than once, because the figure moves with season and trading.
What is a normal working capital requirement?
It varies widely by sector and by how a business is run. Expressing it as a percentage of annual revenue makes comparison easier than an absolute figure, and comparing a business against its own history is usually more informative than comparing it against an industry average.
Is a lower working capital requirement always better?
Not necessarily. A requirement pushed down by thin inventory or aggressive collection can cost sales or strain customer relationships. The aim is a requirement that matches how the business trades, not the smallest number achievable.
Why does the requirement rise when a business does well?
More trading means more inventory and more receivables before any of it converts to cash. The requirement reflects volume rather than profitability, which is why a profitable period can still leave the bank balance lower.
Should working capital be funded with a loan or a line of credit?
A revolving facility usually suits a requirement that fluctuates, since you draw and repay as the cycle turns. A fixed-term product suits a permanent step up in the requirement, such as a move to larger premises or a new product line.
