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Working Capital
Concept of working capital management Evaluating techniques for working capital Operating cycle and cash conversion cycle
Learning outcomes
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
Copyright © 2013 CFA Institute 3
Working capital
FormulaWorking capital= current asset – current liabilities
WC = CA – CLGoals
◦ Adequate cash flow for operations◦ Most productive use of resources
Working capital
Working capital
Current Assets
Cash Account receivable Prepaid expense Merchandise
Inventory Marketable securities
Current Liabilities
Accounts payable Accrued expenses
FormulaCurrent 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
Working Capital Ratio
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 Receivabl
e
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.
Copyright © 2013 CFA Institute 8
Acquire Inventory for Credit
Sell Inventory for Credit
Collect on Accounts
Receivable
Pay Suppliers
Formula
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
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
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
Cash Conversion Cycle
Case:
Case:
Case:
Competitor’s ScenarioItem 1/31/2004 1/31/2003
Revenue 6000
COGS 7000
Inventory 1000 2000
A/R 500 400
A/P 800 900
Average inventory (1000+2000)/2 = 1500
Average A/R (400+500)/2= 450
Average A/P (800+900)/2 = 850
DIO = $1,500 / ($7,000/ 365) = 78.2 days
DSO = $450 / ($6,000 / 365 days) =
27.3days
DPO = $850 / ($7,000/ 365) = 44.3 days
CCC = 78.2+27.3- 44.3= 61.26 days
Competitor’s Scenario
Items Kohler’s company X company
DIO 85 days 78 daysDSO 38 days 27 daysDPO 31 days 44 daysCCC 92 days 61 days
Competitive Analysis