The NOF or operational needs for funds refer to the amount necessary to keep current asset investments running. In this sense, all companies develop their production cycle based on the NOF, a control criterion that, in turn, is influenced by inventories, customer loans, and basic cash needs.
Operational Needs of Funds
Being parsimonious, the best way to define NOFs is as the investment required for the initiative to continue producing products or providing services, bounded within a time frame, the so-called Average Period of Maturation.
Although it is usually separated from a company’s financial strategy in some cases, the truth is that this concept is of great importance in management and is far from being a control parameter merely associated with the operating cycle and operational needs.
Companies with a certain track record know the importance of correctly auditing NOFs. It is an important part of treasury management, the positive effects of which are felt throughout the life of an organization.
The 3 assets: inventories, customer loans, and operating cash.
The assets that condition the NOF are the following.
– The Existences:
A company must ensure a sufficient stock level to keep production activities operational, a product in progress, and merchandise ready for sale.
– Customer Credits:
In most sectors, customers or intermediaries do not pay for the merchandise right when they receive it. Thus, the cash forecast must consider liquidity shortages despite the positive balance.
– Cash Needs:
Likewise, organizations have to face payments of various kinds to continue operating. Therefore, an estimated reserve amount must provide an estimated reserve amount to cover these expenses, which can be variable or fixed.
These three assets, which vary depending on the specific sector and the financial strategy of each organization, must be estimated separately, and constant monitoring must be applied to support cash forecasts.
Product Exploitation Cycle Phases
The phases of the exploitation cycle are the following:
– The storage phase of raw materials or components. These are kept in the warehouse and form part of the inventories, the value of which can be calculated at cost or acquisition price.
– The manufacturing phase: Raw materials are converted into something else, deriving labor costs, for example. Its consumption is understood as a cost associated with the product.
– The sales phase: the finished products are ready for sale. To value them correctly, the costs associated with production and storage are included.
– The collection phase: this is the period between the sale and the collection of the product. Many companies with too much money in the street have had to urgently seek external financing to prevent their operations from stopping despite being covered in the long term.
In addition, it is necessary to consider the average period of payment to suppliers, which is the amount of time that elapses from the supply of raw materials for production until the payment to the companies in charge of supply is executed.
Some studies also include the measurement period between the operating and operating cycles. This would be the best time to calculate the operational needs for funds.
To calculate them, the following section offers the formula and clarifies its application by companies. Some advantages of being rigorous on this point are detailed since the NOFs have an added strategic value in cash forecasting.
Formula to calculate the NOF or Operational Needs for Funds
The formula for calculating NOFs is shown below:
NOF = Inventories + Clients + Cash – Spontaneous resources
To calculate them properly, the following premise must be considered: NOFs integrate the net investments a company requires for its current operating assets to keep its daily operations running after subtracting spontaneous financing.
One of the most outstanding advantages of correctly calculating NOFs and integrating the results into the information necessary to decide is that no company needs to resort to external financing sources. Let’s say urgently, the cost of this type of credit product is much higher than the usual channels arranged for regular financings, such as discount lines.
In short, the correct estimation of the operational needs for funds can make the difference between a company capable of coping with the economic requirements derived from its activity with solvency and another that cannot continue producing despite favorable customer loans.