Key takeaways
- Working capital at 4% of revenue is a rule of thumb for feasibility, not a proven standard or statistic.
- In the hotel example, the days-based calculation gives about 1.4%. The rest of the 4% is a buffer from a conservative judgement.
- As the model becomes more detailed, switch to a days-based approach by business and reflect actual deposits.
The available data is not sufficient to confirm that 4% is a market value. This article therefore presents it as a modelling convention, and shows where the figures come from so they can be checked.
1. What is working capital?
Working Capital = Current Assets − Current Liabilities
Net Working Capital = Accounts Receivable + Inventory − Accounts Payable
Net working capital (NWC) is money tied up in the business cycle. When NWC increases, cash is drawn out of the business; when NWC decreases, cash flows back. In years when revenue grows, the model therefore usually needs additional investment in NWC.
2. Why hotels must reserve working capital
2.1 Accounts Receivable
| Channel | Example payment terms | Effect on AR |
|---|---|---|
| Walk-in / cash / card | Immediate to a few days | Low |
| OTA | 30–45 days after stay | Moderate |
| Wholesale | 30–60 days | High |
| Corporate Account | 30–90 days | Very high |
| Group / MICE | 30–60 days | Moderate |
DSO of 30 days is about 8.2% of revenue, and DSO of 35 days is about 9.6%.
2.2 Inventory
| Item | Example days on hand |
|---|---|
| Food | 5–10 |
| Beverage | 30–45 |
| OS&E | 60–90 |
| Spa Products | 45–60 |
| Cleaning Supplies | 30–45 |
| Mini-bar | 15–30 |
2.3 Accounts Payable
Supplier credit reduces the need for funding. Examples: food 30–45 days, utilities 15–30 days and major vendors 30–60 days. However, actual terms and the ability to pay on time must be checked.
3. The days-based calculation
AR = (Revenue ÷ 365) × DSO
Inventory = (COGS ÷ 365) × DIO
AP = (COGS + OpEx on credit) ÷ 365 × DPO
Hypothetical hotel example, first year: revenue THB 300 million, COGS THB 69 million, OpEx on credit THB 165 million
| Component | Formula | THB |
|---|---|---|
| AR (DSO 30 days) | 300M ÷ 365 × 30 | 24,657,534 |
| Inventory (DIO 45 days) | 69M ÷ 365 × 45 | 8,506,849 |
| AP (DPO 45 days) | 234M ÷ 365 × 45 | (28,849,315) |
| NWC | 4,315,068 | |
| % of Revenue | 1.44% |
4. Where the 4% comes from
Using the 4% rule of thumb on revenue of THB 300 million gives working capital of THB 12,000,000.
| Component | THB | % Revenue |
|---|---|---|
| Days-based NWC per the example | 4,315,068 | 1.44% |
| Judgemental buffer | 7,684,932 | 2.56% |
| 4% assumption | 12,000,000 | 4.00% |
The buffer covers late receivables, ramp-up expenses, on-site cash floats and pre-opening marketing costs. It is a conservative judgement, not a component that can be measured from the financial statements.
Breakdown of components as ranges
| Component | % of revenue (example) |
|---|---|
| Accounts Receivable | +9 to +10 |
| Inventory | +2 to +3 |
| Prepaid Expenses | +1 |
| Cash Float | +1 |
| Accounts Payable | −6 to −7 |
| Accrued Expenses | −2 to −3 |
| Customer Deposits | −1 to −2 |
| Overall NWC | +1 to +6 (midpoint 3.5) |
This table shows that an estimate of about 4% falls within the calculable range. It does not mean 4% is correct for every hotel.
5. Comparison with other businesses
| Industry | Working capital % of revenue (approximate) | Cause |
|---|---|---|
| Retail | 15–25% | High inventory |
| Manufacturing | 20–30% | Raw materials and WIP |
| Construction | 25–40% | Long project cycles |
| Hospitality (Hotel) | 3–6% | High cash transactions |
| Restaurant | 2–4% | Daily cash |
| Spa / Wellness | 4–7% | Higher inventory |
| Airlines | 1–3% | Pre-payment |
The table is a comparative framework based on experience, not a verifiable statistic.
6. Applying it across multiple business units
| Business Unit | Suggested starting working capital % | Reason |
|---|---|---|
| Hotel | 3–5% | Standard hospitality |
| Wellness / Spa | 5–7% | Higher inventory |
| Branded Residences | 6–9% | Long-stay rental, slow-collecting AR |
| Restaurant | 2–3% | Daily cash transactions |
In an initial feasibility, using a blended 4% makes communication easy, but an investment-grade model should separate by business unit (BU) and by actual cash flows, for example deposits that act as negative working capital.
7. Trade-offs
Low working capital (2–3%)
FCF looks better and less additional funding is needed, but if it is too low it will not reflect the ramp-up period.
High working capital (6–8%)
More cash is tied up in the business, additional funding must be arranged, and liquidity risk increases.
WC 4%
It is an easily communicated starting value and should be tested against harsher cases in a stress test.
8. Sensitivity
Example of a multi-business project with total revenue of THB 1,000 million: every 1 percentage point has an effect of THB 10 million on FCF in the year working capital is set.
| Assumption | Working capital investment (THB million) | FCF impact (THB million) |
|---|---|---|
| 2% | 20 | +20 |
| 3% | 30 | +10 |
| 4% Base | 40 | 0 |
| 5% | 50 | −10 |
| 6% | 60 | −20 |
| 8% | 80 | −40 |
The effect on IRR depends on each project's cash flow structure, so it must be calculated from the actual model.
9. % of revenue vs days-based
% of Revenue
Simple and scales with revenue, but does not reflect payment terms and purchasing. Suitable for an initial feasibility.
Days-Based
More detailed, and allows separate assumptions for each component. Suitable for an investment-grade model.
10. Factors that change working capital
Push it higher
- Reliance on OTAs with slow payment
- Wholesale with long credit terms
- MICE or group business that pays slowly
- F&B and spa operations that need to hold stock
- Customers asking to extend credit during a recession
Push it lower
- Direct bookings paid in advance
- Pre-paid bookings
- Customer deposits
- Just-in-Time inventory
- Centralised purchasing
- Memberships paid in advance
11. How to apply it at each stage
- Initial feasibility: use a blended 4% as a rule of thumb, stating that it is an assumption.
- Investment grade: switch to days-based by BU, for example Hotel DSO 30, DIO 45, DPO 45.
- Detailed operating model: separate by channel mix, and combine pre-paid bookings with customer deposits.
12. Conclusion
4% is a convenient starting point for an early-stage model, but it should not be described as an industry standard. The figures used for actual decisions must come from a days-based model, actual collection terms and a liquidity stress test.