1. Working Capital

2. Learning outcomes Concept of working capital management
Evaluating techniques for working capital
Operating cycle and cash conversion cycle

3. Working capital Introduction
Working capital management is the management of the short-term investment and financing of a company.
Definition:
Basic metrics used to evaluate the company's efficiency and its short-term financial health
Describe primary sources of liquidity and factors that influence a company’s liquidity position.
Introduction
Working capital management is the management of the short-term investment and financing of a company.
Cash and cash equivalents, inventory, accounts receivable, accounts payable, short-term loans, etc.
The goals: Adequate cash flow for operations and the most productive use of resources.
Note: Too much cash may result in the company putting too much investment in low and nonearning assets.
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4. Working capital= current asset – current liabilities
Formula
Working capital= current asset – current liabilities
WC = CA – CL
Goals
Adequate cash flow for operations
Most productive use of resources

5. Working capital Current Assets Cash Account receivable Prepaid expense
Merchandise Inventory
Marketable securities
Current Liabilities
Accounts payable
Accrued expenses

6. Current Assets/Current Liabilities
Working Capital Ratio
Formula
Current Assets/Current Liabilities
Anything below 1 indicates negative W/C (working capital).
While anything over 2 means that the company is not investing excess assets.
Most believe that a ratio between 1.2 and 2.0 is sufficient

7. Operating Cycle Is used to measure the efficiency of working capital
The operating cycle is the length of time it takes a company’s investment in inventory to be collected in cash from customers.
Acquire Inventory for Cash
Sell Inventory for Credit
Collect on Accounts Receivable

8. Cash Conversion Cycle
The net operating cycle (or the cash conversion cycle) is the length of time it takes for a company’s investment in inventory to generate cash, considering that some or all of the inventory is purchased using credit.
Acquire Inventory for Credit
Sell Inventory for Credit
Collect on Accounts Receivable
Pay Suppliers
Evaluate working capital effectiveness of a company based on its operating and cash conversion cycles, and compare the company’s effectiveness with that of peer companies.
Operating and Cash Conversion Cycles
The cycle indicates the length of time that cash is invested in current assets (other than cash).
The cash conversion cycle is useful when the company acquires inventory using trade credit.
The length of time associated with a segment in the cycle varies among companies and industries.
Copyright © 2013 CFA Institute

9. Cash Conversion Cycle
Formula

10. Cash Conversion Cycle
1. Days Inventory outstanding (DIO): is the average number of days a company hold their inventory before sell
Formula:
DIO= 365/ inventory turnover*
*inventory turnover= COGS/average inventory**
**Avg. inventory= (beg.+ ending inventory)/2

11. Cash Conversion Cycle
2. Day sales outstanding (DSO): is the average number of days a company takes to collect revenue after sales has been made.
Formula:
DSO= 365/ Account receivable turnover*
*A/R turnover= Sales/average A/R **
**Avg. A/R= (beg.+ ending A/R)/2

12. Cash Conversion Cycle
3. Days payable outstanding (DPO): is the average number of days a company takes to pay its suppliers.
Formula:
DPO= 365/ Account payable turnover*
*A/P turnover= COGS/average A/P **
**Avg. A/P= (beg.+ ending A/P)/2

13. Case:

14. Case:

15. Case:

16. Competitor’s Scenario
Item
1/31/2004
1/31/2003
Revenue
6000
COGS
7000
Inventory
1000
2000
A/R
500
400
A/P
800
900
Average inventory
( )/2 = 1500
Average A/R
( )/2= 450
Average A/P
( )/2 = 850

17. Competitor’s Scenario
DIO = $1,500 / ($7,000/ 365) = days DSO = $450 / ($6,000 / 365 days) = 27.3days DPO = $850 / ($7,000/ 365) = 44.3 days CCC = = days

18. Competitive Analysis Items Kohler’s company X company DIO 85 days
DSO
38 days
27 days
DPO
31 days
44 days
CCC
92 days
61 days