Understanding working capital in NFPs

Don't be put off by the accountant lingo, it's easy to work out how much 'net working capital' your organisation has. And it is a super important piece of information to know if you are moving from an in-advance block grant to in-arrears individualised funding.

"Plain and simple, block grants can make for lazy balance sheets"

Plain and simple, block grants can make for lazy balance sheets. And many organisations just don't have enough net working capital to cope with financial surprises, or fluctuating revenue and/or expenses.

What is net working capital?

In short, it is the money your organisation has to conduct its day to day operations. NB this isn't just simply the cash you have in the bank. You can have oodles of money in your bank account, but still be short on net working capital. It's about the free, untied money you have available. The money you have available to make sure you can deal with any financial surprises and pay your bills as and when they fall due.

One useful way to express net working capital is to see how long you could continue to conduct operations if zero revenue was coming in.

To calculate this, you need 2 financial documents - they can be from your annual report, or your monthly/quarterly accounts if your organisation publishes them:

1. The statement of financial position (balance sheet) and
2. The statement of comprehensive income (profit & loss statement)

You will also need a calculator.

The first 2 numbers you need are from the balance sheet - 'total current assets' and 'total current liabilities'.

Subtract the current liabilities number from, the current assets number.

NB if your current liabilities are bigger than your current assets you may already be insolvent or very, very close.

So using the numbers in the photo above 896,767 - 204,797 = 692,970 write this number down.

Now you need your total expenses from the P&L.

You might have to manually add these up. Or sometimes you have to subtract 'net profit' from 'total revenue'. Different organisations use different reporting formats, but you can always work it out. NB these need to be actual - not budget figures.

Now if it is from an annual set of accounts divide this number by 12. Or, if it is from a monthly P&L divide it by the number of months that have transpired within the financial year. NB get this from the 'year to date' (YTD) column - not the result from that month. This number tells you on average how much it costs in real cash per month to pay for your operations. So using the above number in the photo 922,820/12 = 76,902

Now divide your first result by the second result and you have the number of months you could operate before running out of money.

692,970 /76,902 = 9 months (NB this is waaaaay above the gold standard and may indicate a lazy balance sheet for an entirely different reason!).

How much do you need?

In early 2016, I analysed literally 100s of organisations that were operating under block grants in the disability sector and were about to transition to the NDIS. Many organisations had less than 1 month of net working capital and and several were actually managing to get by with negative net working capital. You can get away with low levels of net working capital under block grants because of the certainty that exists around revenue.

There is no magic number of how many months of net working capital you require under individualised funding. It all depends on your organisation's profile, the type of individualised funding system, and the organisation's exposure to fluctuations in income and expenditure. Most importantly (assuming you don't hold significant inventory), it depends on your accounts receivable and accounts payable average days and your invoicing schedule. The NDIS softened the blow from moving from an in-advance block grant to in-arrears individualised payment by undertaking to pay within 48 hours of a properly lodged invoice.

I'm not an accountant and this shouldn't be taken as financial advice, but generally, it is considered prudent to have somewhere between 6 weeks and 3 months worth of net working capital. Less than 6 weeks may be starting to put you in the vulnerable category - particularly if you are making an operational loss, or going through a growth spurt (generally, growth in an in-arrears payment system eats up cash, at least temporarily). If you are at all concerned, ask your accountant for advice on what is prudent for your individual circumstances. They should also be able to give you some tips on what levers you can pull to increase your net working capital.

Read this 'Saturday quickie' to see what happens to cash as you move from in-advance block grants to in-arrears individualised funding.

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