Operating cash requirements (OFR) is an indicator that identifies the cash investment and immediate liquidity that a given company needs to meet its operating expenses and develop its business.
In a company, the product development process means that long periods of time can elapse from the time raw materials or materials are purchased (payment to suppliers), to the time the final product is produced, to the time it is charged to the customer.
The calculation of the operating needs for funds (NOF) serves to determine the money necessary to continue with the activity during that period in which the company is uncovered and the collections begin to arrive and the investment is recovered, that is to say, a time during which a liquidity deficit is produced. It is a basic tool for planning a company's activity in the short term and for maintaining its solvency.
The NOFs take into account the following assets:
- Stocks: Resources to maintain stock, work-in-process and finished goods, as well as direct purchase of goods for sale.
- Customer credit: This is financing for the purpose of deferring the collection of invoices from customers.
- Operating cash: The money the company has available to cover the costs of its day-to-day business.
In order to calculate the NOF, the maturity cycle of the company's product has to be taken into account:
- The stock phase: This is the phase that lasts from the time the goods are purchased until they are sold.
- The collection phase: This phase takes place from the time the sale of the goods is agreed until the sale is completed.
NOF is calculated by subtracting current liabilities from current operating assets. The first part is the investment made in working capital and the second part is the no-cost financing from suppliers (spontaneous liabilities). The formula, expressed as an equation, would be as follows:
NOF = Inventories + Operating cash + Customers (accounts receivable) - Spontaneous or operating liabilities (accounts payable).
One of the most widely used variants of the NOF is the one used to determine the number of days that each phase of the maturity period lasts. To do this, the average duration of the stock (average stock period or pmp), collection (average collection period or pmc) and payment (average payment period or pmp) phases, expressed in days, is obtained using the following formula:
Average stock holding period (ASP):
pme = (stocks / cost of sales and cost of production) x 365
Average collection period (APC):
pmc = (forward customers / total sales) x 365
Average payment period (pmp):
pmp = (forward suppliers / total purchases) x 365
By substituting in the first formula the values of these operations in days (leaving cash aside) it is possible to calculate the days in which there will be an operational need for funds, from the payment to suppliers to the collection of sales.
Finally, in order to know the real liquidity availability of a company and its solvency in this period, the NOF must be compared with the Working Capital Fund (WC):
FM = current assets - current liabilities
If the working capital turns out to be lower than the NOF, the company has to reinforce its structure with working capital financing.
This situation of lower FM than NOFs is usually found in companies with projects in the initial stage, and/or in the growth phase. The use of alternative financing specialised in working capital (Factoring, Confirming, and Treasury Loans) is a very useful resource for companies in this stage.
