Average Working Capital Over a Twelve-Month Period - In this method, the average working capital over a 12-month (or agreed) period is examined and the average is set as the minimum working capital figure. The challenge in this method is to determine how much was excess during the 12-month period. Often cash is excluded or minimised for this calculation for that reason. One caveat is that if the business is in growth, it will require more working capital so the prior year will not be indicative of the current run rate and/or need to be adjusted. Also, seasonality will need to be taken into account so the business does not run low on working capital during quiet months. Low Water Mark Working Capital Over a Twelve-Month Period This is similar to the above method except the lowest figure is taken representing the lowest that the business is likely to go. Again, the challenge is to determine what a reasonable cash balance would be as more than likely excess cash existed in the business at that point. Net Current Assets at Zero - In this method, it is assumed that the business is cash generative so having current assets and liabilities balanced to zero will result in a situation where the business will not run out of cash. This often works well as the current assets in the form of debtors are often collected faster than many of the current liabilities need to be paid, especially items like corporation tax so the business is always ahead so to speak. This can work well for some businesses but fall over for others that have very slow payment terms from customers or long lead times from stock purchase to a stock sale. This also can become unworkable if growth is steep, which requires more working capital to keep up.
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